How can I be professional when borrowing $$ from friends?

Question

I am currently looking at a duplex deal that will require a $50,000 down payment. I have $20,000 liquid now, and I recently sold a business for $30,000 however I allowed the buyer to make $5,000 payments over the next 6 months. Therefore, I will not have the entire $30,000 for six more months.

I reached out to a friend and allowed him to come up with the terms (we are really good friends.) We decided to not complicate it with interest calculations and I would simply pay him $3,000 for the loan of $30,000, making payments of $5,500 over six months.

I will be receiving $5,000/month for the business and the duplex cashflows $625/month, so I wouldn't/shouldn't need to use any extra money from my W-2 income.

My question is; how to I make it legal and/or professional. Yes, we are friends and I know this agreement would work just fine without any paperwork, however I want to be as professional as possible with this deal in hopes that it may lead to more collaboration in the future.

I'm also wondering how the mortgage lender and the IRS will look at it. Will there be tax implications? Do you see any hiccups that might occur? And if the answer is 'Go talk to an attorney.' What kind of attorney? Real estate attorney? Tax attorney? Estate attorney?

Sincerely,

Terry

Thomas S. · Answer

Draft a contract having him as a partner. At the end of 6 months you then have the option to buy out your partner. Bank, as with any partnership, never needs to know you may be buying him out.

Mike Dymski · Answer

Create a promissory note (on your own or have the closing attorney draft it)It's up to the two of you if he wants to take a second mortgage on the property and, if so, have the closing attorney set it upFind out if your lender is okay with you only providing ~10% of the down payment...most lenders won't...and they will want post-closing liquidityYou are one sneeze away from pneumonia (a vacancy, HVAC goes out, your business partner doesn't pay the $5k, etc.) and then a strained friendship

Account Closed · Answer

@Terry Burwell OPM yes but thats where you need to have a partner . There is a difference between a partner and a loan. For example , if it was a seller finance deal, it might not make a difference to them ( you still have to know you are going to be able to repay them etc. Then a partner potentially opens up other issues. You buy it in 1234 Main Street LLC where you own 50% and John Doe owns 50% . You can have it where you bring half the funds to the table, they bring half the funds to the table or they bring all the funds, you don't bring any funds( this may also be an issue with the lender but just giving you some thought process). Your operating agreement will dictate who does what, pay outs, if your short, who comes up with those funds , and then your buyout provisions etc. This is all going to have to be well with the lender and with the partner ( which I'm not sure what the lender will say ) .Im not trying to throw you under the bus but thats the reality of it and people on BP post good and bad info. There s a lot of creative ways to do things but you want to make sure its legit and ethical because that is so crucial for a good foundation. And by the way, i just told you that you don't have to have any money in the deal , theoretically, but lender and partner have to be on board. This might be tricker when you don't have the experience , track record ,liquidity etc. Some food for thought. Sorry if I came off harsh as I sometimes get irritated when people advocate operating unethically ( because future new investors will read this post and have the same thoughts ) so thats why I just felt it my obligation to make that mention. Good luck in getting your deal done and if you are able to let us know how you did it, maybe that will help the next guy:)

Account Closed · Answer

@Terry Burwell It sounds like if you are getting a gift but its really something you have to pay back then its fraud. Can you bring in a partner to bridge the equity gap ? That way its all done right and not in questionable practice?

Basit Siddiqi · Answer

@Terry BurwellBanks who issue mortgages using Fannie/Freddie guidelines will not allow down payment on an investment property to come from friends/family unless it is a gift.A loan from a friend increases your debt to income ratio(...yes...the bank won't see the loan if its not on your credit report but still; it might be considered fraud if you don;t disclose it).You may want to either ask your friend to be on the loan(if the bank allows it) or to speak with a portfolio lender who is okay with you getting a loan from a friend. Portfolio lenders have more wiggle room on what they can/can't do on a loan.

Terry Burwell · Answer

I hear people doing deals with OPM all the time, and here I am trying to do one and I'm finding some speed bumps. I'm not looking to do anything criminal, just creative. Being professional and legal are very important to me. How would a partner relationship work? Would they then be on the mortgage and deed, or can they be a silent partner that shares in the profit & loss of the property but isn't on the deed or mortgage? Essentially my question is how can I use a partner to acquire the property with the opportunity to buy them out later?

Chris Mason · Answer

Assuming this is an investment property (you didn't state occupancy intent in OP) and a GSE 30YF, even a gift will get shot down once it's in underwriting. I'm guessing that lender hasn't done a lot of investor loans (or that this will be your primary residence).Most lenders will not go for it, but something you can technically do and it still be a GSE 30YF on an investment property is secure the borrowed funds by another property with a notarized/recorded/etc note and deed of trust. This is now no different than using a HELOC on Property A as the down payment on Property B, it's just a private second mortgage instead of an institutional second mortgage. DTI still must work, so your 33.5% interest rate 6 month amortization in OP (not sure why you think there's no interest rate @ $5500/mo for 6 months on $30k, my financial calculator says there is :P) might kill it. Might want to see if your buddy would go for i/o payments (also, is 33.5% usury?). Easiest way to structure this would be to have the note be for i/o, say 10%. i/o on $30k @ 10% will be $30k*10%/12= $250/mo. Assuming there is no prepayment penalty, you'd be free to still pay extra if you wish (say, $5500), but it wouldn't be a requirement so the mortgage underwriter wouldn't hit you with it. If you still want to pay him $3k, have him do a prepayment penalty that'll work out to $3k after including the interest. Basically, have someone good with a financial calculator figure it out such that buddy gets his $3k but it doesn't break the GSE underwrite.

Terry Burwell · Answer

I think this could work. If that were the case, I presume they will want to do a complete check of his credit and finances, would they not? Would his name be on the mortgage and the deed in this case?

Terry Burwell · Answer

I came across a hiccup. I spoke with my lender to see if receiving a loan from a friend would cause any problems and he said I could not receive a loan from a friend as it would require repayment. I would however, be allowed to receive a gift from a family member or domestic partner.How do I make this work?

John Thedford · Answer

Have him give you a mortgage and note for security.