My uncle owned and operated a small farm. That’s what he did his entire adult life. He farmed.
As a boy of 8 or 10 years of age, I remember sitting in his living room in his rural farming community. He was talking about the kinds of things grownups talk about, and he made one comment that has always stayed with me. He said that he and my aunt had made a decision early in their marriage that they would always pay cash for everything, and that if they couldn’t afford something, then they would wait to buy it until they had the available cash. But then my other relatives asked him “What about your house? Didn’t you borrow money to buy your house?” And my uncle replied that of course he had borrowed money to buy his house – but for everything else he had always paid cash.
This exchange occurred many years ago. But it illustrates a common fact. While it’s possible to pay cash for a home, most homeowners end up getting a loan to help them pay for either part or all of the purchase price. As a practical matter, it’s usually just too expensive for most homeowners to pay all cash for a home. Many homeowners, and especially most first time homebuyers, simply don’t have the kind of economic resources they would need in order to be able to pay cash for a home.
There can be several potential loan sources for a potential homebuyer. One of the most common sources is institutional lenders, such as a credit unions or a bank. Family members can also sometimes contribute to the cost of buying a home.
A loan agreement can be either verbal or written. But verbal loan agreements can create a lot of difficulties, including but not limited to proof as to the amount of money that was loaned and the time for repayment. Small, informal loans between friends or family might be done on a handshake, but larger or more formal loans are almost always reflected in a written agreement or promissory note.
One of the most basic forms of loan is an “unsecured” loan, where a lender loans money in exchange for a simple written contract, or promissory note. If the borrower doesn’t repay the loan, then the lender has certain legal remedies available that usually require the lender to go to court. This can result in a court “Judgment” against the borrower. But if the borrower has no money or other assets, then the lender might find that the judgment can’t be satisfied.
In order to protect the lender’s interest, sometimes lenders require a borrower to put up “security” or “collateral.” The word “security” sometimes refers to security consisting of real estate; the word “collateral” is often used to refer to security consisting of personal property other than real estate. The purpose of such “security” is to give the lender a specific asset that can be sold to satisfy and pay off the loan. This can be valuable if the borrower has no other assets which can be sold to repay the loan. If the lender does things properly, then the lender may be able to acquire a “lien” against the security so that the lender’s claim for repayment will be paid first. This can be useful if other creditors might also be seeking repayment from the borrower.
It would be easy for lenders or creditors to misunderstand or misapply the legal principles and requirements involved in lending. Many state and federal laws apply to loans. Violation of these laws can lead to liability and many different problems. It’s generally not a good idea for persons to lend money unless they spend the necessary time and resources to make sure that their loan complies with all of the applicable laws. Persons who are considering making loans should consult with competent, qualified legal and tax professionals to ensure that they fully understand all of the tax and legal considerations involved in making loans.