10/28/08: Refinancing Through Family Makes Sense
By Benny L. Kass
Q: I am looking into refinancing my home from a 5/1 ARM to a fixed rate. During this process my mother stated that she would lend me the $150K to pay off my existing loan and I would pay her back at the current market rate for a 30-year fixed. This would provide her a stable investment and I can forego the closing costs, paperwork, appraisal, etc. associated with the refinance.
What are the legal implications of this transaction? If I pay off my current loan do I assume title? What paperwork do I have to sign with my mom to validate the transaction and where do we file it? She would have to claim the income; can I still write off the interest as I would do with any other home loan? Is this transaction as simple as it sounds?
A: Yes, it is simple and makes a lot of sense. Instead of giving the money to a stranger (your new lender) you will be keeping it in the family. However, I strongly recommend that you retain local counsel to assist you, since there are a number of legal documents and administrative steps that have to take place.
You first have to send a letter to your current mortgage lender, asking for the amount that will be necessary to completely pay off that loan. The lender will send you a pay-off letter, showing the current principal balance plus a per-diem amount. Interest is paid in arrears. That means that the payment you will send in November will cover interest for the month of October.
However, since you will not pay off the loan until mid-November, you will have to send in a check that includes the number of additional days until the lender receives your check. To be on the safe side, I would add three extra days of interest based on the per-diem amount that you receive from your lender.
Once you have the pay-off number, you will have to sign a deed of trust and a promissory note in favor of your mother. It would make sense to have your attorney prepare those two documents for you, and the fee should not be more than $400-500. The lawyer will also record the deed of trust on the land records where your property is located, and there will be a nominal fee that has to be paid to the Recorder of Deeds.
You asked about title. You currently own the property, but it is subject to a deed of trust (the mortgage document). This means that you have deeded the property in trust to a third party selected by the lender. If you pay off the loan, the trustee will release the trust from land records – which is what you have to do after you pay off your current lender.
On the other hand, if you are in default on your loan, the trustee has the power to sell your property at a foreclosure sale. For example, turn to the classified section of today's paper and you will see a large number of properties being advertised for foreclosure by the trustee.
The monthly payments you make to your mother have two parts: income and interest. Your mother will have to declare as income the annual amount of interest that you pay her. And so long as the deed of trust is recorded, you can deduct that interest when you file your tax returns.
Your mother will have to send you and the IRS form 1098 at the end of each year, which will show the amount of interest that you have paid. You can access this on the web, www.irs.gov, and click on publications.
Your mother has presented you with an attractive offer which you should not hesitate to accept.