Family Lending

Mortgage guidelines have specific rules on allowable sources of funds for down payment and closing costs.  In most instances gifts from family are allowed. Gifts are money that will never be repaid.

Sometimes clients ask about getting loans from family for their purchase. This blog post overviews the rules for this arrangement and copies guidelines from Fannie Mae.  Fannie Mae and Freddie Mac makes the rules for conventional conforming loans and these types of loans are the majority of loans in the US.  Furthermore, non-conforming loans typically follow these guidelines as well, as they are a standard for the industry.

In summary, if a buyer is putting down 5% of their own funds and wishes to borrow with conforming financing, they can get a secondary, subordinate loan from family provided it’s secured against an asset that justifies the loan.  Oftentimes, the only asset that is significant enough to secure the loan is the property being purchased. For instance on a $500,000 purchase with a buyer putting down $25,000, some of the financing can come primarily from a conforming loan and some of the financing secondarily from a family loan (with whatever split the borrower/family wish).

This family loan must be at a reasonable interest rate with repayment terms meeting Fannie Mae’s subordinate financing guidelines, explained below.  The family loan would be behind the mortgage loan. A secured family loan is secured against the property just like a mortgage loan is. This is done with a note and deed of trust commonly prepared by the real estate attorney at the title company that’s identified on the purchase contract as the title company.  Templates for these documents are here:

Alex comment: Because of the below rule, all family loans utilized must be secured loans; they cannot be informal.

B3-4.3-17, Personal Unsecured Loans (09/20/2010)
Personal Unsecured Loans

Personal unsecured loans are not an acceptable source of funds for the down payment, closing costs, or financial reserves.

Alex comment: Here’s the guidelines copied and pasted on what is allowed:

B3-4.3-15, Borrowed Funds Secured by an Asset (10/30/2009)

Borrowed funds secured by an asset are an acceptable source of funds for the down payment, closing costs, and reserves, since borrowed funds secured by an asset represent a return of equity.

Assets that may be used to secure funds include automobiles, artwork, collectibles, real estate, or financial assets, such as savings accounts, certificates of deposit, stocks, bonds, and 401(k) accounts.

Secured Loans as Debt

When qualifying the borrower, the lender must consider monthly payments for secured loans as a debt.

Documentation Requirements

The lender must document the following:

  • the terms of the secured loan,
  • evidence that the party providing the secured loan is not a party to the sale, and
  • evidence that the funds have been transferred to the borrower.
B2-1.2-04, Subordinate Financing (08/07/2019)

Lenders must disclose the existence of subordinate financing and the subordinate financing repayment terms to Fannie Mae, the appraiser, and the mortgage insurer.

Acceptable Subordinate Financing Types

The table below provides the requirements for acceptable subordinate financing types.

Acceptable Subordinate Financing Types
Variable payment mortgages that comply with the details below.
Mortgages with regular payments that cover at least the interest due so that negative amortization does not occur.
Mortgage terms that require interest at a market rate.

If financing provided by the property seller is more than 2% below current standard rates for second mortgages, the subordinate financing must be considered a sales concession and the subordinate financing amount must be deducted from the sales price.

Unacceptable Subordinate Financing Terms

The table below describes unacceptable subordinate financing terms.

Unacceptable Subordinate Financing Terms
Mortgages with negative amortization
Subordinate financing that does not fully amortize under a level monthly payment plan where the maturity or balloon payment date is less than five years after the note date of the new first mortgage
Eligible Variable Payment Terms for Subordinate Financing

Fannie Mae permits variable payments for subordinate financing if the following provisions are met:

  • With the exception of HELOCs, when the repayment terms provide for a variable interest rate, the monthly payment must remain constant for each 12-month period over the term of the subordinate lien mortgage. (For HELOCs, the monthly payment does not have to remain constant.)
  • The monthly payments for all subordinate liens must cover at least the interest due so that negative amortization does not occur