As families gather for the holidays, some adult children or their parents will discuss real estate and how to do it. that first home purchase.
For parents who have the funds and the desire to help adult children buy a home, donation of a deposit is one of the most common ways to help. But that’s not the only option.
Here’s a look at some of the ways parents can help their kids become homeowners.
Give a deposit. For owner-occupied property (not an investment property), mortgage lenders typically allow borrowers to use money offered by a family member as part of the down payment. However, if it is a recent donation, borrowers should be able to prove the origin of these funds and provide a letter stating that the money is a donation and does not need to be repaid. .
Bob Collins, a mortgage broker at Signal Hill Mortgage in California, explains that parents who offer a down payment often think of it as “here’s your inheritance up front”, so they can see the benefits of that money while they are alive. .
This approach puts the donor under some control with the lender, but not as much as the other options. “All we have to do is verify that they have the funds to donate, and we get a gift letter,” says Greg Cook, a mortgage consultant in Southern California. “Then they send the money to the settlement agent, and as long as it matches the gift letter, we’re good to go.”
If the gift exceeds the Internal Revenue Service’s annual gift tax exclusion of $ 14,000 per recipient per year, then it may require additional tax documentation. However, a married couple could each give $ 14,000 to one child and the spouse of a child, up to a maximum of $ 56,000 in four separate gift certificates.
Offer a family loan. Given the current low interest rates on savings vehicles, parents with cash to spare might choose to lend money to a family member buy a house instead of getting a traditional mortgage for the buyer. “It’s a victory for both sides,” said Dan Yu, managing director of EisnerAmper Wealth Advisors in New York. “If mom and dad would go to the bank and say, ‘How much are you going to pay me for a five-year CD?’ If the son or daughter went to the bank to try to borrow on a 30-year mortgage, they might have to pay 4%. Both sides of the family win, and mom and dad earn a higher interest rate. [than they’d get from a CD]. “
However, as Yu points out, “It’s not just mom and dad, but rich aunts and uncles do too.” Assuming the parent lender has the cash flow to make the loan and is prepared to do so, the buyer could make an offer not contingent on financing and potentially offer the seller a faster close, which could be a plus on competitive markets where cash offers are the norm.
One thing to remember with family loans is that it should always be self-employed, which means it follows the proscribed IRS interest rates based on the length of the loan.
If the goal is not to earn interest, the parent making the loan can choose to forgo up to $ 14,000 in interest per year under gift tax exclusions ($ 28,000 if he lends to a couple). Otherwise, lenders must report interest payments as taxable income, just as they would report interest on CDs or money market accounts. Borrowers can deduct mortgage interest (assuming they itemize their tax deductions) just like they would with a traditional mortgage.
Co-signing of the mortgage. In cases where an adult child’s income is too low to qualify for a mortgage on the house they want, have a parent co-signs mortgage might help. While they can afford to take on the obligation, some parents may prefer this option if the alternative is for their child to buy in an area they consider unsafe or undesirable.
However, co-signing is a bit improper in this case. “They’re really co-borrowers, and they’re in the business as much as the kids,” Cook says. “They are under the microscope of the lender in the same measure: income, credit, current debt, all the things that we look at for the kids.” If the child’s income is sufficient to claim the remaining balance on his own in the future, the loan could be refinanced in his name alone to relieve the parents of all responsibility.
One potential downside for parents is that the mortgage will show up on their credit as an outstanding loan obligation, which could make it difficult to refinance or buy another home in the future. “They created an obligation for themselves that might limit anything they might want to do in the future,” Collins said. In addition, if the child misses his mortgage payments, it will also have an impact on the parents’ credit.
With all of these options, you should consult a financial advisor first to make sure you can comfortably afford to help without compromising your financial security. You may also want to consult with your tax preparer about the potential tax implications and, depending on the circumstances, ask a lawyer how to structure the legal documents in the event that your child divorces a spouse or defaults on the loan. No one predicts that things will go wrong with real estate transactions, but it can happen, so you better be prepared.