New Rule Allows Family Loan for Down Payment

Parents and grandparents who want to help their kids scrape together money for a home-purchase down payment now have a new legally sanctioned way to do it: They can loan them the cash and even charge interest on it.

Tucked away in Congress’ massive funding bill approved in the closing hours of this year’s session was a long-awaited rule change covering Federal Housing Administration mortgage applications. Originally proposed three years ago by Rep. Bill Orton (D-Utah), the change eliminates the barriers to family down payment assistance.

Under current FHA regulations, family members are allowed to help relatives by providing gifts of cash for the downpayment. But the same rules say such gifts have to be bona fide; that is, the generous family members can’t ask their relatives to pay the money back at some later time. In fact, they have to certify in writing--known as a “gift letter”--that their assistance carries no repayment requirement whatsoever.

Since even the most doting parents or grandparents don’t necessarily have spare cash to bestow on their offspring as outright gifts, the FHA rule has had two effects over the years, according to lenders.

On the one hand, it has caused large numbers of people to tell lies in their applications for federally insured mortgages. They certify that the money they’re contributing to the kids’ down payment is a gift, whereas in reality there’s a verbal agreement that the funds represent a debt that must be repaid.

On the other hand, the old rule has discouraged down payment assistance from family members who don’t want to lie and don’t want to run the legal risk of being caught in a lie by the federal government.

Thanks to the new rule approved by Congress, nobody has to worry about these entanglements any more. Now family members are free to provide cash contributions to relatives’ down payments in the form of unsecured personal loans or even a second mortgage secured by the home to be purchased.

Say your daughter needs $7,500 to buy her first home using an FHA mortgage. You’d like to be able to give her and her husband the money as a gift, but you just can’t afford it. Instead, you now have two new options: Loan it to the kids interest-free, with the proviso that they pay it back on whatever schedule you agree on.

Or you can create a note--with interest--that takes the form of a second mortgage or deed of trust secured by the new house and file it with the local recorder of deeds. That way, if the couple runs into bad luck and the house goes to foreclosure, you’d at least have a legal claim to a portion of the foreclosure sale proceeds.

How you structure the assistance is completely up to you. Since you’re the lender under the new rule, you can customize the financing to fit your own needs and those of the kids.

For instance, if the young couple won’t be able to afford regular monthly amortization of principal and interest, you can tailor the terms to allow no payments whatsoever for the first two years, interest-only payments for the next three years, and a lump-sum balloon payment of all remaining principal at the end of five years.

What if you’re borrowing the cash yourself to provide the loan by drawing on your home equity credit line? Then consider building in a rate structure to your note that mirrors or exceeds the rate you’re paying on the credit line. That way at least you won’t be losing money on the deal.

If your equity line rate is prime plus one--the bank’s prime rate plus 1%--then you could write the same into the note you’re providing to the kids. There’s no prohibition in the new FHA rule to your charging an adjustable rate to those you assist.

The only real drawback is computational: Do you want the hassles of keeping track of constantly fluctuating rates and payments? Possibly not.

What if you’re the kid or grandchild who’d like to take advantage of the new congressional change on down payment aid to buy your first house?

Don’t be shy. Approach your most generous relative with a business proposition: Loan us the $10,000 we need, Grandpa, and we’ll pay you a rate two points higher than what you’re earning on your money market mutual fund.

And best yet: None of us will have to lie about it to the government.

* Distributed by the Washington Post Writers Group.