Using Private Loans to Buy a Home

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Using Private Loans to Buy a Home

Financial institutions aren’t the only places willing to lend people money. Your family or friends might just want to be your private bank. If you haven’t considered this avenue, you may want to at least consider the pros and cons.

Getting a private loan need not be—in fact, should not be—informal or unprotected. You draw up a contract with payment terms and a schedule of repayment. You can structure it in the same way that an institutional loan is structured. The private lender will hold a lien and can require late fees, just as a bank might. If you default, the lender can foreclose.

Advantages

Private loans have some advantages over loans from financial institutions:

• You can negotiate the interest rate. The result could be a relatively low one for you.
• Your lender might still get a better interest rate than he or she could at an institution.
• You can draw up favorable contract terms, such as a longer payback time.
• You could be more flexible if problems arise, such as a job loss, than you could be with a bank.
• You can refinance for little or no cost, depending on what you agree on.

Do the paperwork, too

Simply handing a person money and expecting repayment isn’t a good idea. A private loan should be structured like a business deal; that gives it an air of legitimacy and gravity. It also protects both the borrower and the lender with legal recourse if, for example, the relationship goes sour or the lender decides he wants all the money back for some reason.

Draw up a promissory note that explains your legal obligation to repay the loan, all payment issues (dates due, how often, etc.), penalties, and the interest rate. Draw up the actual mortgage (or "deed of trust," in some states), which puts the home up for collateral in the event you default. Also, draw up a repayment schedule.

Above all, treat a personal loan with the utmost seriousness. Both you and the lender can come out ahead with one. Abusing a loan can destroy the goodwill of a family or friend and even your larger relationship network.