Never loan money to friends and family! Gosh, how many times have we heard that advice? But, what about being the borrower, that can’t be too bad, right? Well, to be sure, money exchanged between friends and family is often tricky.
Financing the building or remodeling of your home is big time. This is not a few dollars to get you by till next pay day or cover a single late payment. On the other hand, the good side of this is that it’s a legitimate investment that can benefit both sides if handled correctly. And handling it correctly is what this article is about.
Emotions get involved and when it comes to money. These emotions can really cause ill will so there are some important guidelines to follow when involving friends and family and borrowed money. But, as I mentioned, if the loan is drawn up correctly and if your “uncle Bob” is treated respectfully and paid well, there should be no problem.
So, whether it’s an uncle, parent, grandparent, business partner, or friend of the family, there is a right way of doing this that makes this a viable option with only a small chance of things going wrong. Be advised that I urge you to utilize the services of a real estate lawyer and this article should not constitute personal advice as to what you should do. Seek proper council!
STEPS AND CAUTIONS WHEN USING FAMILY TO FUND CONSTRUCTION
1) Feel out your likely suitor (“Uncle Bob”) to make sure he is amenable to the idea of investing with you in a real estate project. Be honest and open about what you want to do and ask if he has any interest in making a short term (usually about one year) loan to help you build a home.
2) Research the going interest rates for construction loans and discuss the appropriate rate for this loan. Your rich “uncle Bob” will be taking money out of another investment and losing the earnings on that money. So, find out what he wants to make and how that relates to the going rates for these loans.
3) Follow the same procedures that your project would have to comply with if funded by normal means. If you don’t know what these are, you definitely need to involve an experienced builder or construction manager to help you put these together with you. “Uncle Bob” may be cooperative, but you do not want to take advantage and go beyond the scope of your abilities, this will be disastrous for you both. Here is a quick list of the steps and procedures to follow to prepare:
• Get pre-qualified by a local lender to determine what amount you would qualify for if you were using traditional funding.
• Prepare your house plans, have them approved by local building authorities, create a complete list of necessary building materials, have a builder quote the cost to build your home, and hire a real estate appraiser to project the final value of the finished home on your building lot.
• Assuming that “uncle Bob” is not going to finance the long term, 30 year mortgage once the home is finished, find a lender to pre-approve you for this end loan so that uncle will feel confident about how he will get his money back out of his investment.
• Have a mutual agreement as to how the construction of the home is to be accomplished. Respect the fact that Bob wants to know who is in charge of the building and how it will be accomplished.
4) Set the terms of the loan between you at a rate that is fair to you both so that there are no hard feelings on either side. Your research should tell you what is reasonable. Agree to what you both would accept if something should go wrong. Discussing possible problems at the beginning helps to avoid emotional disagreements later.
5) Find a good real estate attorney to draw up all the papers for signatures. Keeping the transaction professional and proper not only makes everyone more comfortable but it allows you to possibly use “uncle Bob” again in the future! Don’t burn your bridges.
Murphy’s Law says that if something can go wrong, it probably will. I believe that ol’ Murph was a home builder! Yes, my years in the business has proven to me that the best laid plans don’t always materialize. If you both realize the vagaries of building you’ll have a much better relationship.
Indeed, money between family and friends is tricky. But if you’re professional and knowledgeable about the process you’ll do okay. And so will Uncle Bob.