by Craig Venezia

Parents, other relatives, or even friends who lend you money for a house can benefit too.

Bob Hope once said, "A bank is a place that will lend you money if you can prove that you don't need it." Maybe that explains why more and more homebuyers are turning to their loved ones, and even more distant members of their circle, for help with financing. If done right, tapping the "Bank of Family and Friends" can be financially lucrative for both you and the person lending you the money. You get the cash you need, they earn interest at a rate equal to or even higher than they could have gotten elsewhere -- everyone wins.

Commonly called a private home loan, a private mortgage, or an intrafamily mortgage, such a loan is not much different than one you'd get from a bank, credit union, or other institutional lender. As with an institutional loan, you'll normally sign a contract and establish a schedule of monthly repayments with interest. Your private lender will hold a lien on your property and have the legal right to demand full payment on the outstanding balance if you fall behind in making payments. Your private lender can even foreclose if you default on the loan (though few would go so far).

Rest assured, you have legal rights as well. Your parents couldn't foreclose on your house just because you arrive late for their 50th wedding anniversary, and your best friend couldn't demand an early payoff in order to buy a new car.

How a Private Home Loan Helps the Borrower

By turning to the bank of mom and dad, your favorite aunt or uncle, your in-laws, a brother or sister, or even your best friend or business colleague, you might gain the following:

• A lower interest rate. Borrowing from a relative or friend can mean a lower-interest loan than you'd be able to find elsewhere. That's because you and your private lender will set the rate. Because of their personal relationship with the borrower, most private lenders are willing to accept a low interest rate.
• Flexibility in paying back the money. Your loan repayment terms can be negotiated between you and your private lender. That flexibility can allow you to arrange a loan with an unusual repayment schedule at the outset or to later temporarily pause payments due to unforeseen circumstances. Just don't get cavalier about this, or you might strain the relationship.
• Federal tax deductions. Just as with a loan from a bank, private loans allow you to benefit from the federal tax deduction for home loan interest paid.

How a Private Home Loan Helps the Lender

Whether your private lender is a relative or a friend, he or she stands to gain in a number of ways, such as:

• Achieving a better rate of return. Even without paying as much interest as you'd pay to a bank, you can probably offer higher interest than the person could get on current investments.
• Generating a steady income stream. Private mortgages are ordinarily repaid over time as opposed to in one lump sum (unless, of course, you sell your house, at which point you'd have to pay off the private mortgage in full). By setting up and following a repayment schedule, your payments can become a steady income stream for your family or friend lender.