Lending Money to Brother-in-Law

[David Lowe]

My brother-in-law is a contractor with plenty of experience and I believe he does good work. He has seen my success over the years with buy-and-hold properties and is interested in getting into flipping. He is looking for investors among his friends and family and has asked if I'm interested. He has a house locked up that is well below market value and will be doing the work himself (along with his subs). He has 4 investors already and is looking for a few more, with people investing between $25-100k. I am considering investing $25,000 as well. It sounds like this would be considered a personal loan, secured against the house. He is offering a 5% return on a $25,000 investment, and anticipates needing the money for 4 months. Is this a good deal? Are there any clauses I should make sure to include before signing anything with him? I am considering investing with him because I am having a hard time finding SFRs in Charleston at the moment and don't like having investment cash sitting in a savings account. His wife has a good job, so I am confident in his ability to pay the money back even if something bad happens to the house. He is trustworthy and does good work. I have never been on this end of a loan before, so any advice or tips would be much appreciated!

[Chris Lemire]

Hi @David Lowe,

I'm really not sure what your investing criteria are, but make sure you consider lost opportunity cost when deciding to put money into something, and make sure the return you're getting justifies it.

In this example, let's say you decided to go ahead and loan out the 25k at 5%. What does the typical deal you are hunting for look like? Could that 25k be better spent elsewhere? Do you expect to find a better opportunity within the duration of the loan?

As far as the actual logistics of it, a small loan like this can be as simple as a couple of pages, though the content of them may vary a bit from state to state. (I'm not an attorney, consult yours)

The first would be the promissory note, that outlines the terms of the loan, and the second would be a properly recorded mortgage, which defines what collateral can be claimed in the event of default, and the related process for making that claim.

As @Robert Kinsey mentioned, 5% would be a bit low for me as a lender, but I'd be very happy to pay it as a borrower. The trick is just to find a value that both parties are comfortable with.

In my flipping business, I have a hard time securing small loans like this against a property. Depending on the source for the remaining financing, they sometimes prohibit the borrower from recording second mortgages. If he's funding the entire rest of the project himself, that may not be an issue in his business model. Just questions to ask him as you explore the idea.

In the end, just remember that the arrangement needs to be mutually beneficial (especially when dealing with family) and that literally everything is negotiable.

Good luck!

[David Lowe]

@Chris Lemire Thanks for the feedback! 5% seemed low to me as a lender as well, so thanks for the input. Right now the money is sitting in a savings account making a sweet 1.75%, so 5% would be an improvement, albeit a much riskier option. Thanks for the input on the paperwork. Are there any clauses you have found particularly helpful in the past? The remaining funding is coming from my brother-in-law as well as 4 other investors, who are each investing between $25k and $100k. I will make sure to see what collateral can be claimed in the event of a default, especially if the loan can't be secured against the property.

Unfortunately, @Robert Kinsey's post was removed before I had a chance to see it.

Thanks for the tips!

[Thomas S.]

A 5% return over a period of 4 months is not that bad (15% annually) the problem I see is that you are equating the risk of this loan to the fact that it is family (his wife has a good job). This is a mistake. Family increases your risk factor it does not lower it. Family will play on emotions when trouble hits. 

Your security is in your contract agreement not whether you have confidence he will pay back the money. If it goes south and he can't pay you are screwed and so is the relationship with family. Think about it. Is $1250 worth the risk.

[David Lowe]

Thanks @Thomas S., you hit the nail on the head. I figured if things went south I would be the first he would pay back because we're family. That may not be a great assumption, but I also don't think I will be in a position to ask for the first lien on the property with only a $25k investment. Do you have any tips to mitigate the risk? Is it common to include a penalty if I'm paid late, or a clause that says the money + interest is due in 4 months, regardless of the status of the house? Sorry if that is a really basic question.@Thomas S.

[Omar Khan]

@David Lowe I have to agree with @Thomas S. 

Finances and family hardly ever make a good combo. Even if you are in the senior most position, are you willing to, potentially, damage your relationship in case things go south for only $1,250? You might be forced to return money if he gives it to you ahead of everyone else in the same position.

Also, how do you plan on enforcing the late penalty/fee? He could make a (reasonable) case that things out of his control lead to delays. You have to carefully think what you will do in the case. 

I understand that it's super hard to turn down family members. Your particular family member might be super talented. So you'll have to play this by ear, but just remember to think ahead in case things don't work out.

[Thomas S.]

Rather than give advice on how to protect your investment and mitigate risk my advice is do not invest with family. It is not worth the risk.  

[Steve B.]

@David Lowe I think the disagreement is over how you stated the question. Is he offering a 5% cumulative which is 15% annually or 5% annualized?

[William Jenkins]

A 5% return is TERRIBLE.  I'm not sure how he is getting others to commit to those terms but if so I would love to know and use his investors... LOL.  

There is no upside in this thing....  Best case scenerio you make a measly 5% (~$400 over 4 months).  Worst case scenrio you lose a relationship and $25k.

Do yourself a favor and stay out of it.  Whenever I hear people looking at marginal deals because their cash is in savings "earning nothing," I just want to shake my head.  Repeat after me.... "Cash is not trash!"    

[Dennis M.]

@David Lowe This has bad news bears written all over it . You’d be making a bad mistake by taking this arrangement. Family and business don’t mix . There are many many threads on here on how friendships were destroyed and families torn apart all over dirty pieces of green paper ! Don’t do it there’s a good reason so many people always say ” family and business don’t mix”

[Amit P.]

To go along with what others say it is probably best to avoid lending to family members, unless you willing to lose it all (and still continue to have good relations).  That said I get sometimes it just works out that way.  If you are nervous about putting down 25K, can you do a smaller deal and start with say 12K?  Build up a 'business' relationship and grow from there.  If you proceed I would suggest putting everything down in writing (loan amount, interest rate, pay back date, what happens if payback date it missed etc).  Then make sure you have an open discussion with the four of you (you two and both spouses), then sign the doc in the presense of all 4 of you...if everything is discussed and written down it should help set the exceptation.  5% does sound a little low.  Good luck with whatever you decide!

[Sam Shueh]

I would skip that hassle being 20% nobody.  Your chance of recovering is so low esp from your relative.  The going rate is way over 10%. He can borrow against his credit card.

You can get a 13 month CD for $3.25% on internet bank. 100% risk and hassle free. FDIC.

[Account Closed]

If your brother in law needs help, you might want to consider it.  Otherwise, the 5% is below market rates.

Working together is one of the main ways families become wealthy.

The first step would of course be to talk to the spouse(s) that make you brothers in law.

[David Lowe]

Thanks for all the great feedback! Sorry for the lack of clarity; he is offering 5% over the duration, so I would make $1250 after four months (15% annually). It sounds like pretty much everyone says it is a bad idea; that's tough to ignore.

@Account Closed That's an interesting point. He has done quite well as a general contractor and I think he and I could help each other out. I know both wives are on board, but maybe it is better to wait until he has flipped his first property before investing with him. I know he has taken loans from his dad (my father-in-law) in the past and has paid them back, but I haven't seen how he handles adversity if a project goes sideways.

[Odie Ayaga]

@David Lowe if he hasn't flipped a property yet definitely stay away. A 4 month term sounds a bit naive. We were initially offering a 6 month option until a friend in the industry told me it was a bad idea due to how much can go wrong and he was dead on. Also, what kind of structure is he putting all these investors in? Having that many investors for such low dollar amounts sounds like a recipe for trouble.