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January 21, 2002
�My
brother and his wife are in a bind. They are about to close on a new house, but
the old one has yet to go under contract (and they didn't use a sale-contingency
clause). We have the available
funds to loan them the down payment, which will be repaid from the equity in the
old house when it does sell. The
old house has more than enough equity. The mortgage broker on the new house is requiring that we
sign a 'gift letter' stating that the down payment is a gift.
It is not. They would obviously prefer to borrow from us at the lower
interest rate that we would give them. Should we sign the gift letter to make
the lender happy, even though they will actually repay us when the house
sells?�
This
is essentially an ethical decision that I can�t make for you.
However, the ethical issue may not be exactly what you now think it is.
Since
you intend to be repaid on the sale of your brother�s house, it appears that
you are making a loan rather than a gift, and therefore signing a gift statement
is a lie. But before jumping to
that conclusion, lets consider what constitutes a gift in the lender�s eyes.
To
the lender, a gift is a transfer of funds to your brother that imposes no
repayment obligation that could put the mortgage loan at risk.
Suppose the value of your brother�s old house drops so sharply before
it is sold that the remaining equity is less than the amount you advanced.
Then if the transfer is a loan, your demand to be repaid could jeopardize
your brother�s ability to pay his mortgage.
The lender does not want to take that risk.
On
the other hand, if proceeds from sale of the house are sufficient to cover the
amount you advanced, the repayment to you doesn�t endanger the mortgage loan.
In that situation, the lender doesn�t care if you get the money back.
This
leads to the following definition of �gift� in your case.
If you are prepared to be repaid only when your brother sells his house,
and only for an amount that does not exceed the equity realized in the house,
then you are indeed making a gift in the sense that matters to the lender.
You can sign the gift letter in good conscience.
On
the other hand, if you expect to be repaid in full even if the amount realized
on the sale falls short of the amount you advance, the advance is not a gift.
Signing the gift letter would deceive the lender.
If
you do want to be repaid but don�t want to be deceitful, suggest to your
brother that he take out a home equity loan, which he can repay when he sells
his house. This is what most other
homebuyers do in this situation.
In
addition to not placing you in an awkward position, a home equity loan avoids a
hazard that you may not have considered. The
interest rate on the home equity loan includes a �risk premium� to cover the
possibility of default. The
interest rate you charge is lower because he is your brother and you are
confident that he will repay you. Yet
the fact is that you are taking a risk.
Your
loan is unsecured. If God forbid
your brother dies before you are repaid, are you sure his wife will recognize
his obligation to you? Or worse
yet, suppose they are both killed in an automobile accident.
Then you would have an unsecured claim against their estate, and might
end up getting little or nothing.
Bottom
line: it would be best all around if your brother took out a home equity loan.
Copyright
Jack Guttentag 2002
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