Can you take a loan from your relatives to buy a property?

Real estate is considered one of the safest and most profitable investment options. The realty sector is seeing rapid growth, especially in top cities. Buying a property requires thorough financial planning, and one of the secured financing options is getting a home loan. However, loans from banks and financial institutions do not cover the entire cost of the property. The buyer has to bear around 20% of the property costs and other hidden expenses during the purchase from their pocket. Most people turn to friends and family for support during a financial crunch. Many consider getting loans from their relatives as an alternative funding option. Yet, many buyers face the dilemma of whether they should borrow money from your family member or take a home loan from a financing institution. Borrowing from a family member can be a better option, provided you treat this arrangement in a professional manner and not as a personal favour. In this guide, we discuss the pros and cons of taking a loan from relatives.

Benefits of taking a loan from friends or relatives

#1. Monetary savings

The borrower may either not pay any interest or pay only a nominal interest on the borrowed capital, thus saving a substantial amount. For example, a person borrows Rs 30 lakh as a housing loan for a 20-year tenure at an 8% interest rate. Eventually, an amount of Rs 30.35 lakh has to be paid as interest on this amount. If the money comes from personal contacts, the amount or some portion of it could be saved.

#2. Flexible repayment terms and no EMI pressure

The loan from family members can borrowed based on personalised arrangements that suit both parties. This may include flexible repayment terms after mutual agreement. However, when borrowing a loan from a bank or financial institution, an EMI must be paid to the lender consistently throughout the loan’s tenure, irrespective of one’s financial situation. In case of default, a penalty will be levied.  In case of loss of income or some such unfortunate event, the person may be allowed a moratorium period but that would have its own cost.  In the worst-case scenario, the bank can repossess the property and sell it to recover losses. Such problems may not arise, if the lender is a family member. They would know your problems and support you, as you get back on your feet.

#3. Lower interest rates

If the family member or friend lends the money and charges an interest based on a formal contract, the buyer must adhere to the same. If the interest rates are lower, it will save a significant amount of money for the borrower. When borrowing a loan from a bank or financial institution, the interest rates could be higher.

#4. No paperwork

When availing a loan from a bank or a financial institution, one has to submit a wide variety of personal, professional and property-related documents at the time of home loan application. This is not applicable when borrowing from a friend or a family member.

#5. No need to worry about the credit score

While processing a home loan application, banks and financial institutions check the applicant’s credit score. Credit scores are rating given by credit bureaus to borrowers in India, based on factors such as the borrower’s credit history, on a scale of 300 to 900. In case of a poor credit score (below 750), the borrower may be asked to pay a higher interest. If the rating is much lower, the bank could also reject the application. When borrowing from a family member, the need to take care of this factor does not arise.

#6. Saves time

Once a person decides to borrow and there is someone willing to lend, a legal agreement can be drafted to proceed with the home purchase. While banks take a lot of time to examine various documents to gauge the applicant’s creditworthiness and approve the loan, the process is much simpler and faster when borrowing from friends or family.

#7. Tax benefits

If you get the home loan documented and pay interest on the same, one can also claim tax deduction of up to Rs 2 lakh under Section 24 of the Income Tax (IT) Act. However, other deductions under Section 80C, Section 80EE and Section 80EEA, are not allowed.

Deduction applicable on interest repayment on home loan taken from family, friends, relatives

According to Section 24 of the Income Tax (IT) Act, a maximum tax deduction of up to Rs 2 is applicable on the interest payment on a housing loan. A tax benefit is also applicable if the loan has been availed for repair and reconstruction of the house with a deduction of up to Rs 30,000. However, the tax deduction for the interest repayment can be availed only after the construction of the house has been completed or its possession has been  received. The Income Tax Act, 1961 does not mention that this deduction shall be available only if the loan is availed from specified banks.

No deduction on principal repayment on home loan taken from family, friends, relatives

According to Section 80C, a tax deduction of up to Rs 1.5 lakh is available on the repayment of the principal of a loan availed for buying or constructing a new house only. One should note that the deduction is applicable only if the loan is availed from banks, Life Insurance Corporation (LIC), central government, state government or other notified institutions and only if the repayment is made. Repayment of the principal on the loan taken from  family members, friends or relatives or any money lender cannot be claimed as a deduction.

Advantages of taking a home loan from friends or family

See also: All about home loan tax benefits

Downsides of taking a loan from friends or relatives

Lack of clarity

In the absence of a formal contract, borrowing money from a family member or friend could pose challenges. The informal nature of such loans may create confusion regarding the interest payable, penalty and other repayment terms. This could pose the risk of legal disputes. Thus, in the interest of both parties, a formal agreement should be signed, which outlines the agreed terms and conditions of the loan.

Delays in repayment can impact relationships

While going for monetary assistance from family members or friends may seem to be an easy option, the borrower will be required to repay the money in most cases. However, the decision to borrow the money from a friend or family member in the first place or any delays in the repayment could put both parties in an awkward situation. Sometimes, it could even damage happy relationships.

Tax implications

With the aim of regulating personal loans from friends and relatives, the government has put in place certain regulations. The first rule is one cannot accept a loan exceeding Rs 20000 in cash or by bearer cheque. Transactions such as electronic transfers, payee cheques, bank drafts, etc., should be made through a bank account. This rule applies even if the amount borrowed is in instalments. Secondly, repayment must be paid wholly or partially through cash or bearer cheque. A penalty will be applicable in case of any violation.

Tips to keep in mind when taking home loans from friends or family

Borrowing money from a relative or a friend to buy a house may have a bearing on one’s personal life, if anything goes wrong with the arrangement. Here are some tips to follow:

Have the transaction documented

Even if one is availing the loan from a close family member such as father or mother, it is better to keep it documented. Paying some interest on the loan is also recommended. This arrangement, besides offering tax benefits, would also ensure that the borrower does not feel guilty about taking the loan. It will ensure the lender does not regret their decision later.

Repay within the stipulated time

Even if the lender is one’s personal contact, it is in their best interest to treat this agreement as completely financial. One should also allow the lender a reasonable timeline, within which the loan can be repaid.

Alternate ways to finance a house purchase

Consider a joint home loan

When applying for a home loan, consider adding a co-applicant, which will increase one’s eligibility to get a higher loan amount. Moreover, one can avail of higher tax benefits, provided each of the applicant is contributing to the loan repayment. In case of a joint home loan, each co-applicant is eligible to individually for the deduction of up to Rs 1.5 lakh on principal repayment and Rs 2 lakh on interest payment.

Selling assets

Another popular option is to liquidate assets such as jewellery, stocks, or other investments to generate funds. The proceeds from the sale of personal assets can an ideal source of funds for the down payment during a property purchase.

Housing.com News Viewpoint

When borrowing a loan from a family member or a friend, it is essential to keep the transaction document, supported by a formal agreement to avoid potential conflicts. Make sure you establish a transparent communication channel with your lender and adhere to a clear repayment plan. If required, you may seek the help of a third party or a legal professional. Approaching a lawyer may be a good idea as they may help you adhere to the tax and other regulations.

FAQs