With a private mortgage, you don’t borrow from a bank. Instead, you borrow from another person or business. Whether it’s your only option, or one of many, you should understand how a private mortgage works and what to watch out for.
What do you need for a good private mortgage? Start with the following items, and you’ll be on your way to a win-win situation.
Understand the Risks of a Private Mortgage
Any private mortgage can go bad. Life brings surprises even when everybody has good intentions and the deal looks like a great idea. With that in mind, consider the following questions before you get too deep into something that will be difficult to unwind:
- How will the personal relationship between borrower and lender change?
- Will the lender’s financial security (retirement, risk of bankruptcy, etc) be affected?
- Who else may suffer if the loan is not repaid?
- Is the property in good condition?
- Will the property be adequately insured and cared for?
- Is there any other lien, mortgage, or interest conflicting with the private mortgage lender’s interest?
Private Mortgage Agreements
Any private mortgage should be documented. Use a loan agreement that clearly sets everybody’s expectations. Documentation protects each party to a private mortgage, and may help with tax and legal issues. Spell out every detail, including:
- When are payments due?
- What if payments aren’t received?
- How/where should payments be made?
- Can the borrower prepay?
- Is the loan secured?
Securing the Loan
It’s a good idea to secure the lender’s interest - even if you do a private mortgage among close friends or family members. That way, the lender can take the property and get some money back in a worst-case-scenario.
For example, a borrower (who has the ability and every intention to repay) may die or get sued. If the property is held in the borrower’s name without a properly filed lien, their creditors can go after their home or pressure them to use the home’s value. A secured private mortgage helps protect the lender’s interest. In fact, the term "mortgage" technically means "security" - not "loan."
Securing the property may also help you save on taxes.
How to do a Private Mortgage Correctly
You have to think about unpleasant possibilities when considering a private mortgage. Imagine what could go wrong and how it would affect you.
For documentation, work with qualified experts. Talk to local attorneys, your tax preparer, and others who can help you through the process. Some online services provide private mortgage agreements, servicing, and file documents for you: