Does a Family Loan Make Sense for You?

Inter-family loans can help lender and borrower, and offer lower rates and customized terms.

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Banks may not be lending money these days but friends-and-family loans might just be a recessionary growth industry. Such loans, formally structured and documented like bank financing, also can be a flexible tool to allow older homeowners to work with children to tap equity in homes they do not want to sell at today's depressed prices. Interest rates and fees can be sharply lower than loans arranged through a bank or other financial institution. And terms can be customized. Want an 11-year mortgage? No problem here.

Wealthy households have long used lawyers or accountants to fashion these deals. Now, the internet has spawned online services providing comparable packages for families of more modest means. Virgin Money, generally seen as the leading provider of such loans, began life early this decade as Circle Lending, and was relaunched in its current form in 2007 after British entrepreneur Sir Richard Branson bought a majority of the company. It's done about $400 million in inter-family and other "social" lending to date, with half of that during the past two years. A key to inter-family lending, noted Virgin marketing director Helen Payne Watt, is to price the loans keeping in mind what is known as the Applicable Federal Rate -- a group of short, medium and long-term interest rates set each month by the federal government. By using loan rates at or above the level of AFRs, family loans are not considered gifts by the Internal Revenue Service and enjoy the same tax deductions as commercial loans.

The good news is that AFRs are lower than conventional loan rates -- much lower in some cases. The long-term AFR, for loans with maturities of nine years or longer, is now 3.6 to 3.7 percent. The AFR for short-term loans of three years' maturity or less is only .83 percent (yep, that's an annual rate of less than 1 percent). Most families are structuring loans with rates above these minimums, Watt notes.

Another big benefit of inter-family loans, particularly for mortgages, is a much lower set of fees, particularly if title to the property is not changing hands in the transaction. Virgin's basic fee package for its Family Mortgage is $649 for the documents alone; its full-service package to manage the loan adds another $50 plus $9 per payment. "If the family is providing the financing and not transferring ownership, then the full service is OK," she says. "If the ownership of the home is changing hands, then you'd need a full closing." Virgin charges about $2,000 for such a closing.