Private mortgages have become increasingly popular amongst consumers in the United States who have been practically shut-out of the public mortgage market over the later course of the 2000’s and early 2010’s. Instead of borrowing money as part of a publicly backed mortgage through a traditional bank, the money is instead borrowed from a business or other person. Before seeking out a private mortgage; however, it behooves consumers to understand how a private mortgage works and how to avoid pitfalls that could be associated with the financial transaction.
The Risks of a Private Mortgage
Similar to private loans, any private mortgage can go bad for a variety of reasons. These can be due to malicious causes or just things going awry in the life of the mortgagor. When seeking a private loan from a family member, thoughtful consideration should be paid to how the personal relationship between the two parties can or will change. Will the person who borrows money from their parent or sibling feel like they are constantly indebted to the person? Will the financial security of the lender be at risk if the borrower defaults on the loan? Who else that is personally connected to the transaction could be hurt or suffer if the mortgage goes into default? As a result of these potential consequences, many consumers choose to seek out a private note through a business or company offering these services to avoid the potential family issues.
Lenders are also at risk when making the choice to provide private mortgages as an investment. Other reasons that can make seemingly good deals go bad include: the overall condition of the property being borrowed against? The odds that the borrower will actually take good care of the property and insure it, and if there are any other mortgages, liens, or other interests conflicting with the private lender’s financial interest in the property? Failure to realize that one may not be the only creditor with a financial state in a foreclosed property can result in a significant loss of money to the lender.
How to Do a Private Mortgage Agreement
All private mortgages need to be properly documented in order to protect both the lender and the borrower. The loan agreement should clearly state the expectations of both parties in the transaction. Proper documentation will also help the borrower claim interest on taxes (if allowed) as well as work other potential legal issues. Some of the finer points that should be outlined in a private mortgage agreement include stating: when payments are due on the loan, what occurs if payments are not received, when and how the payments should be made, if the loan is secured or not, if the borrower can prepay the loan, and if private mortgage insurance (PMI) is required. If PMI is a requirement, then the lender will also need to state when PMI automatically stops being paid by the borrower (typically when the loan reaches a loan-to-value (LTV) percentage of 78%). If LPMI (lender paid mortgage insurance) is being provided, then the specific terms of the higher interest raid should also be laid out in the mortgage agreement. Some private mortgage lending companies will have other disclosure forms that are required to be signed or initialed during loan closing as well.
Securing a Private Mortgage Loan
A good idea for all types of private mortgage lenders is to secure the lender’s interest when backing a private loan. Even if the mortgage is going to be between close family friends or siblings, securing the loan helps the lender by allowing him or her to foreclose on the property and get financial capital back in the event the borrower can no longer afford the home (or passes away).
One good example is the case of when a borrower gets sued or possibly passes away (this is the good-case borrower who has the means to pay the loan as well as the intention to fulfill his or her obligation to the note). If the property does not have a properly filed lien against it by the lender, then other creditors can then pursue the home or pressure the borrower to borrow against the loan’s value to pay them back. If the mortgage is property secured, then the lender’s interests are better protected. Additionally, by securing the mortgage, there may be larger tax breaks available to the borrower depending on what state the home is located in.
Information Required by Private Mortgage Lenders
The following examples are indicative of information required by private mortgage companies when considering individuals for private mortgages. The specific documents required may vary by lender and state of residence.
Private Refinance Loan Administrative Requirements
When refinancing a private mortgage, most lending companies will ask you for the following documentation:
– Your W-2 tax forms for at least the past two years.
– Pay stubs from your job for the past month.
– All pages of your bank statements from the past three months.
– Copies of all pages of your most recent investment and retirement account statements.
– A copy of the current promissory note and settlement statement for the current home loan.
– A legible copy of your driver’s license or state ID card and U.S. Social Security Card.
– A letter explaining any known credit issues.
– If you have been divorced previously, a copy of the fully executed divorce decree.
– If you are self-employed, work in sales, own rental real estate, or are paid by commission, most private lending institutions will also require you to provide:
- The last two years of personal tax returns, signed, and including all schedules for the return.
- If you have started a corporation, including the past two years of corporate returns, the current loss statement, balance sheet, and the year-to-date profit of the business may be required.
Private Mortgage Home Purchase Administrative Requirements
– Your W-2 tax forms covering the past two years.
– Your payment stubs from the past 30 days.
– All pages of your bank statements covering the past 90 days.
– A copy of your driver’s license and social security card.
– Your most recent investment and retirement account statements (including all pages of the statements).
– If divorced, a copy of the fully executed divorce decree.
– A letter of explanation for any known credit problems.
– If the consumer has selected a property, have a copy of the fully executed purchase agreement to provide to the lender.
– For self-employed mortgagors, those who work in sales, own rental real estate, or work by commission, the following information will likely be required by the lending company:
- Two years of all personal tax returns to include all schedules filed with the returns.
- If you work for yourself under a corporation, the previous two years of corporate tax returns in addition to the company’s loss statement, balance sheet, and the year-to-date profit and loss statement.
Avoiding Private Mortgage Pitfalls
Most consumers who get in trouble with private mortgages normally fail to do their due diligence before entering into a loan with friends, family, or unknown business investors. Even more dangerous is the “self-educated” consumer, who “thinks” they can figure out all of the nuances of the required paperwork for a private mortgage and avoids paying an attorney or tax preparer to help them through the process. Most professionals recommend that individuals take their time and be judicious before entering into a potentially risky mortgage loan or even investment. Some other private mortgage pitfalls to avoid if you are entering the market include:
– Paying a “Good Faith” or “Qualifying” mortgage payment prior to closing on the loan. This has become a common scam in the ever-growing private mortgage lender market. The “scammers” aren’t dumb, they will walk the potential borrower through the entire process of obtaining the loan. Then, just prior to “closing,” the scammers will ask the borrower to provide the “good faith” payment to allow them to do some type of “underwriting” test on the client’s credit. Once the payment is made, it may or may not ever be used against a home loan on behalf of the borrower.
– Getting tricked into thinking you can’t possibly qualify for a publicly backed mortgage by private lenders. This is becoming more and more common today as the U.S. housing market starts its slow recovery. The more shady private companies will prey on the fear of the consumer that they can’t possibly qualify for a publicly backed loan and get them to accept a much higher interest rate than they might qualify for through a normal mortgage company. Even if one is convinced that they wouldn’t possibly qualify for a publicly backed mortgage, it is still worth making sure as the difference in monthly or annual cost could be significant.
– Just not knowing what is different with a private mortgage as compared to a traditional note. Let’s face it, most consumers can get a little lazy when it comes to properly researching home loans. Private mortgages aren’t necessarily “Easy” to obtain, the lenders of these loans just have a bit more flexibility on when they can extend credit and at what interest rate. Consumers should know what they are getting into when taking out a private mortgage and pay special attention to both the interest rate of the loan and any required balloon payments.
– Failing to hire a lawyer to review the home loan paperwork is another common pitfall for investors closing on a private home loan. This is especially more important when dealing with a company located out of town or that you have not heard of before. In the majority of locales throughout the United States it will only cost a consumer a few hundred dollars in order to have a real estate attorney review the closing paperwork. This small amount of money can pay huge dividends in the future if it helps you avoid paying excessive fees or a higher-than-allowed interest rate on the home loan.
– Not researching the company or people involved with the private home loan. In today’s economy, it has almost become a necessary evil to research the individuals and companies that we deal with in every-day life. You’ll be amazed at what type of information will turn up in a basic Bing or Google search on a company to include any past scam allegations. If the mortgage is being coordinated by a local mortgage broker, they will be required to be licensed by both your state as well as the National Mortgage Licensing System & Registry. The company should be in good standing with both organizations or you should back away from the loan quickly! Additionally, it never hurts to submit inquiries to the local and national branches of the U.S. Better Business Bureau to ensure there are no significant complaints against the company from the recent past.
– Giving the down payment on the private mortgage directly to the lending party. Most reputable private mortgage lenders (or savvy ones who understand all of the rules and regulations associated with private loans) will typically instruct you to make the down payment check out to a trust that will not approve payment until you personally approve of the transaction. This trust will normally be maintained by a different lawyer who does not have personal ties to either party in the transaction. This action provides additional comfort to the lender; however, they will have to follow-through on the sale of the home before seeing the money.
– Failing to understand the full impact of a private mortgage balloon payment. Balloon payments will vary in their usefulness. They basically are a large, lump-sum payment that comes due downrange in the mortgage’s life. Most borrowers will seek out balloon payments in order to keep their monthly payments on the property as low as possible; however, many home owners fail to realize the discipline required to save this much money up.