Unique Financial Considerations for Co-op Buyers

Much of the standard financial advice regarding homeownership doesn't apply to co-ops. Here's a summary of what's different: * Two-tiered financing. Two-tiered financing. Two loans are often involved with co-ops. First, the cooperative will take out a mortgage for its purchase of the property (which you'll probably help pay for, as part of your regular maintenance fees). Later, you'll probably need a loan to purchase your shares. Two loans are often involved with co-ops. First, the cooperative will take out a mortgage for its purchase of the property (which you'll probably help pay for, as part of your regular maintenance fees). Later, you'll probably need a loan to purchase your shares.* Higher down payment. Higher down payment. Co-op boards frequently require buyers to make large down payments-often upwards of 25% of the purchase price. Your co-owners have good reason for this: They want to make sure you're in sound financial shape and can afford your monthly maintenance payments. Co-op boards frequently require buyers to make large down payments-often upwards of 25% of the purchase price. Your co-owners have good reason for this: They want to make sure you're in sound financial shape and can afford your monthly maintenance payments.* Higher interest rates. Higher interest rates. Some lenders are reluctant to finance co-op purchases, because if a buyer fails to pay on time, there's no house to foreclose on, only intangible shares in a corporation. Fewer willing lenders and greater risk translates into higher interest rates. Some lenders are reluctant to finance co-op purchases, because if a buyer fails to pay on time, there's no house to foreclose on, only intangible shares in a corporation. Fewer willing lenders and greater risk translates into higher interest rates.* Tax deductions. Tax deductions. Tax deductions for co-op mortgage and maintenance payments are more complicated than with condos or single-family homes. While the co-op management will help you calculate how much of the maintenance payment can be deducted, you may need to consult a tax professional. Tax deductions for co-op mortgage and maintenance payments are more complicated than with condos or single-family homes. While the co-op management will help you calculate how much of the maintenance payment can be deducted, you may need to consult a tax professional.* Flip taxes. Flip taxes. A "flip tax" is a misnomer-it's really a transfer fee levied by the co-op when a member sells. It can be calculated different ways: for example, based on the number of shares the seller holds, a flat amount, or the sale price. Usually the seller is responsible for this fee, but the seller may pass it off to the buyer. A "flip tax" is a misnomer-it's really a transfer fee levied by the co-op when a member sells. It can be calculated different ways: for example, based on the number of shares the seller holds, a flat amount, or the sale price. Usually the seller is responsible for this fee, but the seller may pass it off to the buyer.

What's Next?

You've probably got a good idea of which traditional method for financing your home works, if any. Still, you might want to consider alternatives. In Chapter 7, we'll discuss such methods as borrowing from family or friends or getting government-assisted or seller-backed financing.

CHAPTER 7.

Mom and Dad? The Seller? Uncle Sam? Loan Alternatives

Meet Your Adviser Asheesh Advani, President of Virgin Money USA, Inc. (based in Waltham, Massachusetts; see www.virginmoneyus.com), and an expert in alternative forms of home financing.

What he doesWith a background in finance and development economics, including a stint at the World Bank, Asheesh came to realize the enormous volume of loans that are informally done between individuals rather than through banks. He founded CircleLending Inc. in 2000, which managed thousands of person-to-person loans and mortgages (including seller financings) every year. The company was acquired in 2007 by Sir Richard Bransons Virgin Group and rebranded Virgin Money.

First houseIt was a condo in Boston, on the top floor of a two-story house-a beautiful older house that had been totally renovated inside, with stainless steel appliances, hardwood floors, and still the old-house trim. The yard was tiny, about 10' x 10'. Wed planned to live there for about five years, figuring we would have had a child by then. Then within less than two years, we realized we were having twins! We quickly moved to a single-family home in a Boston suburb. In fact, we bought the new house before selling the condo, which everyone advised us was terribly risky. But this was still during the real estate heyday, and we ended up selling quickly, at a six-figure profit.

Fantasy houseId like what Id call a George Washington slept here house-very New England, with historical significance and atmosphere. In fact, our current house was built in 1836 and was a broom factory-we like to joke that its haunted, though its not. Ideally, the place would be partially fixed up so that were not doing major renovations but would still have potential for personalizing.

Likes best about his workCreating something new! CircleLending was a totally new concept and was a joy to grow from idea to company. And were continually brainstorming-its great working with people who have more ideas than we can ever hope to bring to life. We feel like our product helps people get the home of their dreams, sometimes when theyd almost given up on finding adequate financing with a reasonable interest rate and repayment plan. One client said that the banks she approached were ready to approve a certain amount for the home purchase, but nothing for her moving expenses-and she figured shed need $20,000 to move her and her young family, a prohibitive sum. We helped her arrange to borrow this amount from her mother, at a lower interest than a bank would have offered, and she proceeded with her home purchase.

Top tip for first-time homebuyersPick the house based on where you like to actually live, not based on how much money youll make. People obsess about whether its the right neighborhood, or whether theyre timing the market correctly. Buying a house is such an emotional decision-making it a financial one could, in the end, hurt you.

CD-ROM.

For more tips from Asheesh Advani, check out his audio interview on the CD-ROM at the back of this book.

With competing payment pressures from student loans and other bills, and the high cost of housing, it's hard-if not impossible-to come up with all the cash needed to buy a house. You may be struggling to get a down payment together or to qualify for a mortgage you can live with. And most traditional loans don't provide much flexibility, especially if down the road you want to make an adjustment to your payment schedule.

If this sounds familiar, we suggest you look into alternative, more flexible or affordable forms of financing. (Yes, this could mean your mother-but keep reading; it may be worth it.) We'll cover: * gifts or loans from family members and friends* financing directly from your house's seller* low-down payment loan programs available through federal, state, and local agencies, and* special financing options available for new homes, such as direct financing from developers (buydowns).

No Wrapping Required: Gift Money From Relatives or Friends

Don't be shy: Many first-time homebuyers (nearly one-quarter) get some gift money from a relative (usually their parents) or a friend, according to the National Association of Realtors. If used for the down payment, such gifts help buyers reduce their monthly mortgage payments or increase the amount of house they can afford. Large gifts may even be used to finance the entire purchase. Some buyers also use gifts for moving costs, home furnishings, and remodeling.

By making your home purchase possible, the giver gets not only emotional satisfaction, but financial and tax benefits. If someone is planning on leaving you money by inheritance anyway, a gift is a way to reduce the size of their taxable estate (large enough gifts can be taxed, though the laws on this are continually in flux). And better yet, your parents or other gift givers can watch you enjoy the money during their lifetime, rather than watch you pay extra interest to a bank.

For advice on approaching your parents or others for a cash gift, see the discussion below on borrowing money from family or friends.

How Gift Givers Can Avoid Owing Gift Tax

Believe it or not, the IRS attempts to keep track of cash gifts-and if someone makes total gifts over a certain amount during his or her lifetime, that person's estate can end up owing "gift tax," even though the recipients of the money don't! Fortunately, not every gift counts toward this total, and the gift giver has to give away quite a bit of money for it to apply. Anyone can give a tax-free gift up to $12,000 per year to another person (2008 figure, it's indexed to go up with inflation) without any tax implications. That means, for example, that every year, your mother and father can give you $24,000 (plus $24,000 to your spouse or partner, if you have one), without it counting against the lifetime tax-free limit.

EXAMPLE: Leslie and Howard would like to buy a house for $240,000 and hope to raise a 20% down payment, or $48,000. If each set of parents gives Leslie and Howard $24,000, the couple have reached the needed amount, with no tax liability for anyone. Leslie and Howard would like to buy a house for $240,000 and hope to raise a 20% down payment, or $48,000. If each set of parents gives Leslie and Howard $24,000, the couple have reached the needed amount, with no tax liability for anyone.

If a relative or friend wishes to give you more than $12,000 during a single year, that person will need to file a gift tax return (Form 709) with the IRS. This doesn't mean the gift giver will have to pay gift taxes, because computing the gift tax debt is (as of recent years) put off until the giver's death. At that time, the first $1 million of all the gifts made over the person's lifetime will be exempt from the tax. For more information, see IRS Publication 950, Introduction to Estate and Gift Taxes Introduction to Estate and Gift Taxes, available at www.irs.gov. If a sizable amount of money is involved, your relative or other gift giver should consult an estate planning or tax attorney.

Why You Need-and How to Get-a Gift Letter

If you use gift money to buy your house (not just furniture), your bank or mortgage lender will require written documentation from the gift giver stating that the money is in fact a gift, not a loan. Remember, the lender is carefully evaluating how heavy a debt load you'll have. It wants to make sure it's not competing with another creditor for your monthly payments.

The "gift letter" should specify the amount of the gift, your relationship to the gift giver, and the type of property (the exact address, if you know it) for which the money will be used. Most important, it should state that the money need not be repaid. Ask the gift giver for a letter or prepare your own for the giver's signature. Your lender may also have a gift letter form.

CD-ROM.

The Homebuyer's Toolkit on the CD-ROM includes a "Gift Letter" you can tailor to your situation. A sample is shown below. A sample is shown below.

If the gift money hasn't been transferred to your account yet, the lender may want verification that the money is available, including the name of the financial institution where the money is kept, the account number, and a signed statement giving the mortgage lender authority to verify the information.

Preventing Emotional Fallout From Gift Money or Family Loans To avoid family blow-ups, it's usually best if parents or relatives discuss the gift or loan with other close relatives (like your siblings). Intrafamily loan expert Asheesh Advani advises that parents offer to make similar loans on the same terms to all children and document the transactions. Asheesh explains: "Preferential treatment, or lack of documentation of intentions, can cause jealously and conflict, especially if loans remain outstanding at the time of death and the children have differing recollections of the parents' intentions."

Gift Letter

All in the Family: Loans From Relatives or Friends

Private loans are an increasingly popular way to finance a home: About 7% of first-time homebuyers borrow money from family or friends, according to the 2008 NAR "Profile of Home Buyers and Sellers." (And that's just for their down payment. It doesn't include those lucky buyers whose parents lend them the entire purchase amount.) Before you say, "Oh no, not my family," consider that the numbers probably wouldn't be this high unless there was something in it for the family member or friend, too. Take a look at the total amount of interest you're likely to pay before your mortgage is paid off-wouldn't it be better to keep that amount within the family?

This section will explore private (also called intrafamily) loans, including: * different ways to structure a loan from family or friends* the benefits for borrower and lender* how to raise the issue with your family member or friend, and* dealing with the legal and tax issues concerning private financing.

Structuring the Loan

You can use a loan from family or friends for your: * Down payment. Down payment. An intrafamily loan can be helpful if you're short on cash and want to avoid paying for private mortgage insurance (PMI), but can save up to pay back your private lender over time or when the house is sold. An intrafamily loan can be helpful if you're short on cash and want to avoid paying for private mortgage insurance (PMI), but can save up to pay back your private lender over time or when the house is sold.* First mortgage. First mortgage. You could sidestep the traditional lending industry and finance your entire purchase price with a mortgage loan from your relatives, friends, or others. You could sidestep the traditional lending industry and finance your entire purchase price with a mortgage loan from your relatives, friends, or others.* Second mortgage. Second mortgage. A private loan may also be used to supplement a bank mortgage. How is that different from a down payment loan? Your private lender records the mortgage publicly, putting themselves in line behind the bank for repayment if the house is foreclosed on-a good way to protect the private lender. It's unwise to forgo this step unless the loan is relatively small (less than $10,000), for the reasons discussed below. A private loan may also be used to supplement a bank mortgage. How is that different from a down payment loan? Your private lender records the mortgage publicly, putting themselves in line behind the bank for repayment if the house is foreclosed on-a good way to protect the private lender. It's unwise to forgo this step unless the loan is relatively small (less than $10,000), for the reasons discussed below.

If you're borrowing part of the house's purchase price from an institutional lender, check whether it requires you to structure your private loan in a certain way or limits the amount you can privately borrow. For example, if you're borrowing down payment money, many institutional lenders require that at least 5% of the purchase price comes from your own funds.

Especially if a sizable amount of money is involved, you should get some advice on how to structure the loan from a real estate attorney. You may also find it useful to work with an outside firm such as Virgin Money (described below).

Benefits of Intrafamily Loans to the Borrower

Some of the reasons that first-time homebuyers turn to family and friends for help financing their houses include: * Interest savings and tax deductions. Interest savings and tax deductions. Family and friends often charge 1% to 2% interest points less than conventional lenders, resulting in thousands of dollars in interest savings over the life of the loan. And if you document the loan properly (as we describe below), you can usually deduct the mortgage interest charged on your taxes, just as with a traditional mortgage. Family and friends often charge 1% to 2% interest points less than conventional lenders, resulting in thousands of dollars in interest savings over the life of the loan. And if you document the loan properly (as we describe below), you can usually deduct the mortgage interest charged on your taxes, just as with a traditional mortgage.* Flexible repayment structures. Flexible repayment structures. While a bank is probably going to require an unchanging monthly payment schedule, a private mortgage holder might be more flexible. For example, you may mutually agree that you'll make quarterly (not monthly) payments or delay all payments for the first few years. And if down the road you want to temporarily pause payments (perhaps to take unpaid leave from work after the birth of your first child), your parents or other private lender may agree to that. Good luck finding such a flexible institutional lender. While a bank is probably going to require an unchanging monthly payment schedule, a private mortgage holder might be more flexible. For example, you may mutually agree that you'll make quarterly (not monthly) payments or delay all payments for the first few years. And if down the road you want to temporarily pause payments (perhaps to take unpaid leave from work after the birth of your first child), your parents or other private lender may agree to that. Good luck finding such a flexible institutional lender.* No points or loan fees. No points or loan fees. Institutional lenders often charge thousands of dollars in loan application and other fees. Family and friends don't. Institutional lenders often charge thousands of dollars in loan application and other fees. Family and friends don't.* Easier qualifying. Easier qualifying. Your relatives or friends probably won't require that you have a great credit score. You qualify as long as your lender trusts that you'll pay back the loan. Your relatives or friends probably won't require that you have a great credit score. You qualify as long as your lender trusts that you'll pay back the loan.* Saving on private mortgage insurance. Saving on private mortgage insurance. If you borrow more than 80% of the house purchase price from an institutional lender, you'll have to pay PMI. By borrowing privately, you can avoid this cost. If you borrow more than 80% of the house purchase price from an institutional lender, you'll have to pay PMI. By borrowing privately, you can avoid this cost.* Minimal red tape. Minimal red tape. To borrow from an institutional lender, you must fill out an application form and provide documentation verifying every item on the form, then wait for approval. Friends and family don't usually adopt this level of scrutiny. To borrow from an institutional lender, you must fill out an application form and provide documentation verifying every item on the form, then wait for approval. Friends and family don't usually adopt this level of scrutiny.* Better deal on the house. Better deal on the house. If you've arranged private financing in advance and can close quickly, sellers who are time pressured may accept a slightly lower offer. If you've arranged private financing in advance and can close quickly, sellers who are time pressured may accept a slightly lower offer.* No lender-required approval of house's physical condition. No lender-required approval of house's physical condition. Private lenders don't usually require that a house's major defects be repaired before closing, as institutional lenders do. That would let you buy a fixer-upper and take care of its defects later. (Of course, you should still have the house professionally inspected.) Private lenders don't usually require that a house's major defects be repaired before closing, as institutional lenders do. That would let you buy a fixer-upper and take care of its defects later. (Of course, you should still have the house professionally inspected.)

Benefits of Intrafamily Loans to the Lender

Here are a few ways that making a private loan can also benefit your family members or friends: * Competitive investment return. Competitive investment return. You can offer to pay an interest rate that's higher than your lender could get on a comparable low-risk investment like a money-market account or certificate of deposit (CD). (And you're still likely to pay less than you would to a bank.) You can offer to pay an interest rate that's higher than your lender could get on a comparable low-risk investment like a money-market account or certificate of deposit (CD). (And you're still likely to pay less than you would to a bank.)* Ongoing source of income. Ongoing source of income. Some investments just sit there and gain in value or pay occasional dividends. With your private loan, your lender will receive regular payments from you, which can be reinvested. Some investments just sit there and gain in value or pay occasional dividends. With your private loan, your lender will receive regular payments from you, which can be reinvested.* A financially liquid asset. A financially liquid asset. Some investments, such as long-term CDs, are hard to cash out in an emergency. Don't worry; we're not saying your family lender can change his or her mind. But he or she can potentially sell your mortgage to someone else. (There is a secondary market for the purchase and sale of existing mortgages, or you may be able to refinance if your lender wants out.) Some investments, such as long-term CDs, are hard to cash out in an emergency. Don't worry; we're not saying your family lender can change his or her mind. But he or she can potentially sell your mortgage to someone else. (There is a secondary market for the purchase and sale of existing mortgages, or you may be able to refinance if your lender wants out.)* Low risk. Low risk. Your parents or other private lender can count on two things: first, your commitment to repay the loan, somehow, someday, even if the original repayment schedule needs to be rejiggered; and second, that your house offers collateral. If worse comes to worst, you can sell it and repay the loan. (Or your lender can foreclose on you, though few would ever do that.) Your parents or other private lender can count on two things: first, your commitment to repay the loan, somehow, someday, even if the original repayment schedule needs to be rejiggered; and second, that your house offers collateral. If worse comes to worst, you can sell it and repay the loan. (Or your lender can foreclose on you, though few would ever do that.)* Emotional satisfaction. Emotional satisfaction. Don't underestimate the sense of achievement that your loved ones get by watching you gain a foothold in the world, with their help. Don't underestimate the sense of achievement that your loved ones get by watching you gain a foothold in the world, with their help.

Borrow from Mom and Dad. When Amy decided to buy a 1904 farmhouse in Northampton, Massachusetts, she assumed she'd get her mortgage from a bank. Then, her mother made her an offer she couldn't refuse: Borrow $180,000 from Mom and Dad, at a competitive 5.75% interest rate. Her mother notes, "I figured, 'Why is my daughter paying the bank when she could be paying me?'" In addition to helping their daughter, Amy's parents earn a decent yield on a low-risk investment, not easy in these days of low interest rates. "It's a little bit scary borrowing from your parents, but this is an official thing," says Amy. And her mother jokes, "The mortgage was actually $173,000, but she wanted a little extra for shoes." When Amy decided to buy a 1904 farmhouse in Northampton, Massachusetts, she assumed she'd get her mortgage from a bank. Then, her mother made her an offer she couldn't refuse: Borrow $180,000 from Mom and Dad, at a competitive 5.75% interest rate. Her mother notes, "I figured, 'Why is my daughter paying the bank when she could be paying me?'" In addition to helping their daughter, Amy's parents earn a decent yield on a low-risk investment, not easy in these days of low interest rates. "It's a little bit scary borrowing from your parents, but this is an official thing," says Amy. And her mother jokes, "The mortgage was actually $173,000, but she wanted a little extra for shoes."

Will Private Financing Work for You?

Still feeling hesitant? The following questions will help you decide whether private financing will work for part or all of your home financing: * How much money do you need? How much money do you need? If it's $5,000 or $10,000 to help with the down payment, that will probably be a lot easier to come by than $50,000 or $100,000. If it's $5,000 or $10,000 to help with the down payment, that will probably be a lot easier to come by than $50,000 or $100,000.* How long do you need to borrow the money for? How long do you need to borrow the money for? Some private lenders may be fine with a ten- or 20-year repayment period (and for tax reasons, may actually prefer a longer term). But if your relative or friend wants the money completely repaid in a few years, make sure such an arrangement is financially feasible for you. Some private lenders may be fine with a ten- or 20-year repayment period (and for tax reasons, may actually prefer a longer term). But if your relative or friend wants the money completely repaid in a few years, make sure such an arrangement is financially feasible for you.* Do you have any other options? Do you have any other options? Is your credit so bad that no bank will approve the loan (or you'll only qualify at really unfavorable terms)? Is your credit so bad that no bank will approve the loan (or you'll only qualify at really unfavorable terms)?* Does a close relative or friend have the money to lend for the amount and term you need? Does a close relative or friend have the money to lend for the amount and term you need? If your parents are well-off but are going to need money soon for retirement or to pay your brother's college tuition, they may not be in a position to help. If your parents are well-off but are going to need money soon for retirement or to pay your brother's college tuition, they may not be in a position to help.* What are the personal costs to you? What are the personal costs to you? If you risk hurt or jealous feelings of siblings, cousins, or others; a sense of perpetual debt or guilt; or similar hazards, the loan may not be worth it. If you risk hurt or jealous feelings of siblings, cousins, or others; a sense of perpetual debt or guilt; or similar hazards, the loan may not be worth it.* What are the costs to set up a private loan? What are the costs to set up a private loan? Getting specialized help from an attorney and accountant to structure your private mortgage may run in the thousands. Consider companies like Virgin Money that can set up and manage the loan for much less or just go back to your conventional lender, especially if the private loan would be fairly small (say, less than $10,000). Getting specialized help from an attorney and accountant to structure your private mortgage may run in the thousands. Consider companies like Virgin Money that can set up and manage the loan for much less or just go back to your conventional lender, especially if the private loan would be fairly small (say, less than $10,000).* Does your family member or friend trust you? Does your family member or friend trust you? Your lender wants assurance that you'll eventually pay the money back, so not only love, but trust, will be key. If you have a history of credit problems and debts, you'll need to show concrete evidence-to your lender and yourself-that you've learned how to responsibly handle debt. Your lender wants assurance that you'll eventually pay the money back, so not only love, but trust, will be key. If you have a history of credit problems and debts, you'll need to show concrete evidence-to your lender and yourself-that you've learned how to responsibly handle debt.

How to Approach Mom, Dad, or Another Private Lender

Even people who are convinced that private loans are a win-win proposition may blanch at the thought of asking for one. But if you approach it like a business proposition, it's not so hard. You're offering a loan at a fair rate of interest, secured by a promissory note and a mortgage.

To present it this way, of course, you'll need to find the appropriate time and place. Never surprise a potential lender by blurting out a request at a social event or informal occasion, such as on the way back from shopping. Make an appointment, even if you see your parents (or brother or old roommate) regularly and the formality seems odd. Give them a general idea of what you want to talk about, but save the details. For example, you might say, "As you know, I'm actively house hunting now and lookng for various ways to finance this. Rather than go into all the details now, I'd like to sit down and talk with you about this." If you sense resistance, back off gracefully.

If you get a positive response, schedule a specific time to meet. Be prepared to discuss your proposition logically and honestly. Ideally, you will have done a lot of homework trying to arrange a loan from a traditional lender, so you'll have all the numbers at your fingertips. Bring along photocopies of all relevant documents, such as the financial materials you pulled together for your bank or other lender.

Prepare a separate one-page list of key terms and issues you want to discuss with a relative or friend, including: * the amount you want to borrow, at what interest rate and repayment schedule (see below for advice)* the amount of money you have available for the down payment (the higher it is, the lower the lender's risk of loss)* your financial ability to make monthly payments (even without setting rigid qualification rules, your lender will want to know)* the financial protections you'll offer the lender (a promissory note and mortgage, as described below), and* the financial benefits to the lender (how your proposed interest rate compares to money-market and CD rates).