Accumulating a down payment and funds for closing costs have always been a hurdle for first-time home buyers. Combined with rising home prices, gig economy jobs, and staggering student loan debt, homeownership can seem out of reach for many millennials. As a result, more parents are stepping in to help their adult children attain the American dream.
Here’s a look at how parents can help their children realize the goal of home ownership and what to consider before you sign on the dotted line.
STEP 1: CAN YOU AFFORD TO HELP?
Much like oxygen masks on an airplane, you should first make sure your own finances are in order before helping your child. Don’t compromise your ability to pay your own bills, meet your own mortgage payments, or maintain your standard of living in retirement.
The last thing you’ll want to do is borrow against your own residence or retirement funds to help now – and end up having to move in with them later.
Talk to your financial advisor first and consider alternatives like allowing them to live with you for a preset time to save up a down payment, or bolstering their credit by adding them to your accounts.
STEP 2: LAY OUT SOME GROUND RULES
Finances can often lead to conflict even in the most loving of families. Gift givers can often be frustrated by what they perceive as a misuse of the gift . Those that receive the gift can also feel frustrated by strings attached to the gift. Gifts to one child can lead to jealousy or resentment by other children.
Consider creating a structured, businesslike distance that lays out your expectations, extent of your assistance, and consequences for any monetary transaction.
Other things to consider:
- Disclose the gift or help to your immediate family.
- Use contracts and let a lawyer or other real estate professional review it for any details that might be ambiguous or overlooked.
- Document all gifts (Cash and items) to siblings to make sure they are treated equally.
Having a clear contract can help define everyone’s expectations, and if the worst happens, and a parent dies or becomes incapacitated, there’s a clear history of the transaction and any ongoing obligations.
STEP 3: FIGURE OUT WHAT KIND OF HELP MAKES SENSE FOR YOU.
There are many ways you can help your child– that don’t necessarily require you to gift it to them outright, including
- Gifting the funds for a down payment.
- Co-owning the house with your child (dividing the equity in whatever percentage you choose; when the house is sold, you get your money back).
- Buying a multi-unit property (or a place big enough for roommates) and renting the other unit(s) to offset the cost.
- Financing your child's home purchase with yourself as the lender.
THINKING ABOUT GIVING THEM CASH?
Tax-wise, giving cash to your children can be a better bet than paying the deposit yourself. For 2020, you and your spouse can each give up to $60,000 ($15,000 x 2 gifting parents x 2 recipients) per calendar year without impacting your lifetime gift tax exemption. If your child is not planning on buying until next year, you can do the same in 2021 (assuming the IRS doesn’t change the amount.) The $120,000 will not count as income or be subject to federal income tax on your child’s tax return.
Note: you’ll want to be clear that this is a gift, as opposed to a loan, which would impact your child’s debt to income ratio. Your lender will require you to provide a “gift letter,” signed by you and your child, that specifies the amount and transfer date of the gift and states that you don’t expect repayment. The lender will also ask your child for two months of bank statements. If they show a large deposit of funds, the lender will ask you to document its source.
Even if you provide a down payment, your child will still have to qualify for the mortgage, and that includes having cash reserves on hand, a steady job and stable income. That said, mortgage lenders typically allow the down payment on a primary home to be made up completely or partly with gift funds so long as other requirements are met. Freddie Mac's Home Possible Advantage mortgage, for example, allows the entire 3% down payment to come from gifts or other funds.
RATHER MAKE IT A LOAN?
On one hand, there’s more stringent government rules to adhere to, and you might have to foreclose on your own child. On the other hand, you can earn close to 3% on a long-term loan, which is considerably more than what a savings account or certificate of deposit pays. Your child will save on closing costs, private mortgage insurance and interest because the cheapest traditional 30-year loans charge well more than the rate you could offer. Learn more about becoming the bank here.
CO-SIGNING AND CO-BORROWING
Is your child overrun with debt? Is their credit history a bit questionable? If your child can’t qualify for a mortgage on their own, you could apply jointly for it, as a non-occupant co-borrower. (Cosigning is also an option, although in that case you’d have liability for the mortgage but no interest in the property.)
Note #1: the mortgage interest deduction may only be taken by a person who pays the mortgage and owns (or partly owns) the home. If the parent holds the property title but the child makes the mortgage payment each month, neither can take the interest deduction. If the child owns any percentage of the home, he or she can deduct that share of the interest.
Note #2: A parent who cosigns for— or gives money to—a married child who then divorces could get entangled in a messy division of assets, and could lose some or all of the investment to the ex-spouse.
Still worried about your child qualifying? If your lender is still hesitant to loan, or you’re not sure that your child can handle the monthly payments themselves, now might be the time to talk to them about waiting and saving more before they buy.
BUYING IT YOURSELF
There can be significant tax deductions possible if you can afford to buy a property and allow your child to live there. Property taxes, mortgage interest, repairs, maintenance and structural improvements are generally deductible on a second home. Keep in mind, while a landlord can deduct up to $25,000 in losses each year, it’s different for family. If the child pays no rent, it is considered personal use of the property and rental-related deductions are not allowed.
If the child has roommate, or it’s a multi-unit property, you may be able to take the rental-related deductions while allowing your child to live there rent-free.
However, second homes or investment properties often require larger down payments- up to 20-30%, as well as higher interest rates. If the kids are creditworthy, you may be better off gifting funds or co-signing.
THE BOTTOM LINE
Who wouldn’t want to help their child buy a home? For those with the means, it can help give your child a substantial step up. Homeownership provides tax benefits and security, as well as helping to build a good credit history. It can help offset your own taxes, or those of your child. If the property is an investment, you might even turn a profit.
But no matter how you decide to approach it—gift, loan, co-ownership— make sure it makes sense for your situation and doesn’t put your own credit or retirement in jeopardy. To set yourself up for success, put it in writing, i.e. a legal contract and get a professional’s opinion. This may be an act of love, but it needs to be considered a business arrangement between you and your offspring to avoid messy inter-family drama.
Otherwise, well… you know where they live.