Going to the Bank of Grandma for a mortgage

Originally published in the Financial Post on January 29th, 2010. To go to the Financial Post website, please click here.

During the spring of 2009, Susan and Steve Beck decided it was time to trade up from their condominium to a single family house. After selecting a two-storey house in Toronto, they started shopping around for financing. Shortly thereafter, an offer came from an unconventional source. Steve’s grandparents said they would lend the couple $200,000.

“We purchased the home and they gave us a better rate than the bank so we just took the mortgage from them. They approached us. They were more than willing. They had done it before with other grandchildren,” says Ms. Beck.

Mr. Beck’s grandparents issued a $200,000 bank draft to Susan and Steve who in turn gave it to their lawyer, who transferred the funds on closing. The grandparents didn’t hire a lawyer but drafted a promissory note which listed the amount of the loan, the monthly payment schedule, the two-year term and an interest rate of 2%. The loan from the grandparents was combined with the proceeds from the sale of the condominium and personal savings — and the $500, 000 home was theirs.

But despite the generous offer, Ms. Beck had reservations.

“I didn’t want any issues within the family because of it. His grandparents have their own kids and I was worried that their children would have an issue. That was my only concern,” says Ms. Beck.

The Becks (not their real name) joined the growing number of couples who are receiving funds from parents or grandparents to purchase a home. While sometimes the boomer bankers give the money as a gift — and it doesn’t have to be paid back — in other cases it is a more formal loan arrangement.

In the United States the National Association of Realtors notes that the number of first-time homebuyers receiving money from parents and grandparents is rising “dramatically.” San Carlos, CA-based RE/MAX agent Lottie Kendall closed a US$680,000 residential property sale in which the mother of the purchaser provided a US $600,000 private family mortgage.

For the young and the property-less, love money delivers a house in less time. The funds are often used for the down payment so the couple can qualify for a bank mortgage. Alternatively young couples whose down payment is less than 20% of the purchase price might be required to purchase mortgage insurance and incur its associated costs, plus taxes and other fees (www.cmhc-schl.gc.ca). Insurance could typically bring a one time cost of $2,750 for every $100,000 borrowed.

Also, the interest rate on family mortgages is usually well below what the banks are offering. The Becks interest rate of 2% is about half what the banks were offering. The Becks will save about $8,000 in interest during the two-year term.

“While it certainly could be risky loaning money to family or a friend, in the right situation it can benefit both parties — the lender gets a good interest rate; buyer saves on loan fees, lender’s title insurance, etc.,” says Ms. Kendall.