Faced with finicky lenders, would-be home buyers are increasingly turning to Dad, Grandma or rich Uncle Louie —even perfect strangers they met online. While these solutions are understandable, given the abundant bargains on the market, they also present some risks.
This year, one-third of first-time home buyers received a cash gift or a loan for a down payment from family or friends, according to the National Association of Realtors. A 22% increase over the historical average.
Meanwhile, so-called peer-to-peer lending sites Prosper and Lending Club say demand for home-related financing is on the rise. Weemba, a social-networking site, launched a platform in September to connect lenders directly with prospective home buyers and other borrowers. And, iSellerFINANCE, a social finance web platform for buying and selling seller-financed properties and the resulting notes is planning to launch in January of 2012. In addition to the platform, iSellerFINANCE has a proprietary credit-scoring engine that will track payment history and update credit scores, which is great for those needing to re-build their credit.
Driving the demand, say financial advisers, is that despite rock-bottom mortgage rates around 4%, traditional lenders remain reluctant to provide mortgages to anyone with less than stellar credit. And in certain markets lenders are requiring down payments of more than 20% of the home’s purchase price.
Scott Nguyen, a human-resources analyst, was denied a mortgage by several banks before getting a $15,000 loan from his mother and sister to use as a down payment on a home in Costa Mesa, Calif. Mr. Nguyen says he has agreed to pay off the loan on a monthly basis over three years, and will end up paying $3,000 in interest.
“Without my mom and my sister’s help, I don’t think I would have been able to buy the house that I did,” he says.
In so-called intrafamily loans, the borrower often saves on interest since parents are likely to charge less than the banks, says Michael Garry, a fee-only financial planner in Newtown, PA. And parent lenders can earn a higher return from their child’s interest payments than they would on a certificate of deposit or money-market fund. Under federal law, on a loan of more than nine years, parents in most cases must charge at least roughly 2.8%.
Of course, intrafamily loans can upset the family dynamic.
Jonathan Bergman, a certified financial planner at Palisades Hudson Financial Group in Scarsdale, NY, recommends that parents be clear about how repayment will work. In some cases, it may even make sense to hold back on future monetary gifts or inheritance if it isn’t repaid. “The power of the parents’ purse is strong,” he says.
Consumers who want to look beyond the family can apply at online sites like Lending Club, Prosper, Weemba and iSellerFINANCE. If approved for a loan after a screening by the companies, applicants may then receive money from investors. These sites also take the sting out of intrafamily finance by separating the parties via an intermediary and using structured financial documents.
At iSellerFINANCE.com, registered buyer-members will be able to post seller-financed proposals, and registered seller-members (including banks and credit unions) will be able to review the seller-financed proposals, and directly contact those buyer-members they are interested in.
However, these alternative routes to financing can be expensive for borrowers. Rates at Lending Club run from around 7% to 28%, and at Prosper from roughly 7% to 35%. The companies say these rates, which are fixed, are higher than traditional mortgage rates in part because their loans are unsecured. At iSellerFINANCE.com, the rates generally run from 7% to 18% because they are normally secured by real estate or other assets. Still, this is a great way to find a seller-financed property and get into your first home while re-building your credit at the same time.