Possible ways to return the money I borrowed from my family for down payment.

[noviceattax]

Situation so far: I and my brother both are on housing market. My brother is finding it difficult to spot a house they want however I have found some desirable houses. We both have done some savings for down payment, let's say $BD is my brother's saving, $MD is mine, and currently they are parked some high yield Bank CDs so that we can withdraw them anytime immediately as we find a suitable home.

What we are thinking to do: Till my brother doesn't find a home I will use his down payment savings as well for my home purchase. And as soon as he finds a home I will take additional loan and return his down payment money.

Why we are thinking to do so: By doing so I will be able to:
1. Avoid PMI on my home loan
2. Get better rates for the entire loan
3. Save on the difference of the Bank CD and mortgage interest rate for the amount $BD. (Don't worry we will not be loosing on my benefit of tax deduction on mortgage interest, it will rather get better only. I can tell the details if necessary.)

What are our questions:
1. This plan is contingent upon the idea that I should be able to get a quick second loan or increase my existing loan and give $BD back to my brother immediately when he finds a suitable house. How much feasible is this? i.e. Will I be able to get more loan from a lender to return my brother's portion towards my downpayment? If yes, what are the pros and cons of it.
2. What other pros and cons do you see of this?
3. Any better suggestions for this?

Please do not hesitate to ask for any clarification.

Thanks,

[tagteam]

See https://turbotax.intuit.com/tax-tips/tax-payments/irs-tax-rules-for-imputed-interest/L7UbulHpC

You can treat this as a loan, which it appears to be, and pay the applicable federal rate (AFR).

See https://www.irs.gov/applicable-federal-rates

[Mike9241]

talk to financial institutions. second mortgages generally carry a higher interest rate than first mortgages and complete refinancing will involve again paying mortgage closing costs and points. no one knows where internet rates will be when your bro finds a home so you could end up with higher or lower rate mortgages.

cashing in CDs before maturity usually requires forfeiting some of the interest earned. talk to the bank.

finally family loans. if over $10K IRC 7872 takes effect which involves imputed interest for certain loans which seems to apply in your case. though no interest needs to actually be paid to your bro (lender), he would have interest income and you would have non-deductible interest expense.

special rules apply if the loan is less than $100K:

(1)Limitation on interest accrual for purposes of income taxes where loans do not exceed $100,000
(A)In general
For purposes of subtitle A, in the case of a gift loan directly between individuals, the amount treated as retransferred by the borrower to the lender as of the close of any year shall not exceed the borrower’s net investment income for such year.

also you have to look to the financial institution. some may not like the fact you're borrowing some of the down payment from your bro. 

[NCperson]

@noviceattax on the lending aspect.... let's say you are going to put down 20%  which consists of 10% of your own money and 10% of your brother's savings.

First, the bank is going to ask the source of the downpayment.  You are going to have to say 1/2 is borrowed.  That is going to cause underwriting issues and could cause the loan to be denied. 

Even if you get the loan approved under those circumstances, it is quite unlikely any bank is going to offer you a 10% second mortgage shortly after closing on the first. 

The scenario you describe is EXACTLY what got the mortgage industry into trouble (among other things) leading up to the financial crisis in 2008:  Banks were originating 80% first mortgages and then taking back a "silent secord" for 10% so that PMI was avoided.  It was a disaster! When real estate prices crashed, those silent 2nds were worthless!

PMI is not a "bad thing" is let's people get into homes with little down.  Have you looked at the cost of PMI versus the cost of a 2nd mortgage?

with 10% down and excellent credit, and 12% coverage, the cost of PMI is 22 b.p. per year on a fixed rate mortgage or $198 per year on a $90,000 loan (10% down).  

If instead of a $90,000 loan, let's say you take out a $80,000 loan and then a 2nd loan for $10,000.  At 11% on the 2nd,  it would cost $1100 per year (less the cost of the first mortage or $750 per year on that $10,000.).  So even if you could get a bank to lend you the 10%, it would be approx $350 more expensive in interest costs and PMI would only cost $198 per year.  The PMI could be cancelled once the loan amortises below 80% but the interest is locked in for the life of the mortgage. 

 Why try to avoid PMI???????