Between interest rates remaining at pre-COVID-19 levels and an aging generation looking to downsize, the frequency of intra-family real estate transactions and deals with untraditional financing are on the rise. Often times, this involves the seller holding a note and mortgage. While this can be a great strategy for both buyer and seller, there are things to be wary of on both sides.

On the seller side, private financing can be a great way to give a family member a deal on a house in an otherwise tough market and maintain a steady stream of income through payments under the promissory note. However, sellers must ensure they are charging the appropriate amount of interest to avoid having interest imputed to them. More specifically, the IRS sets minimum interest rates for transactions. Presently, the interest rate fluctuates between 4.5-5%. If the financing arrangement between buyer and seller includes an interest rate lower than the applicable IRS minimum rate, or no interest at all, the IRS will assign the applicable minimum interest rate anyways. So, you may be required to pay tax on income you didn’t actually receive.

On the buyer side, unlike dealing with a bank (that will, in theory, be around forever) the seller or other family member holding your note could pass away before full payment has been made to them. You might be hoping that means your debt is forgiven, but that isn’t always the case. The note becomes an asset of the seller’s estate and you remain obligated to pay your monthly installments to the estate. Through this process, you will be dealing with an executor or administrator of an estate and could be pressured into obtaining traditional financing to payoff the private loan so the estate can be closed. Alternatively, and especially with family deals, the individual who passed might have included a section in their estate plan that the debt is to be forgiven when they pass.

If you’re looking to explore whether private financing may be the right fit for your real estate transaction, please contact us. We can walk you through the common pitfalls and make sure your interests are protected and wishes honored.