Should You Give Your Kid a Down Payment?
Tips & Trends
From Rory S. Coakley on some of the latest real estate news and happenings.
Ken and Denise Holick had always intended to help their children buy homes. So when their daughter Katie, 26, told them she’d been apartment hunting for weeks in Columbus without turning up any good prospects, Ken threw out an idea: Why not buy?
To cement the deal, the Holicks stepped up with a $9,700 gift to cover a 3.5% down payment, FHA loan fees and closing costs on a $107,000 condo. Katie’s monthly payment including condo fees is $886, about what she would have paid in rent.
“We figured now, when she’d have a reasonable chance of finding something she could afford, was the right time to help,” says Ken.
With home prices and mortgage rates appealingly low and no-money-down loans nowhere to be found, more young adults are turning to family to get into their first home.
Over the past year, 36% of first-time buyers got help with their down payment from family or friends, typically parents, according to the National Association of Realtors ®, up from 28% the previous year.
If you want to give your child a leg up on a home purchase, first make sure you’re on track to hit your retirement goals, says Scarsdale, N.Y. financial planner Jonathan Bergman. Then you’ll need to figure out whether you want to give her the money, extend a loan, or cosign the mortgage. Use the guidelines below to help you decide.
Make a gift if…
- You want to chip away at your estate. Right now, you and your spouse can each give $13,000 tax-free per year to your child (and another $13,000 each to his or her spouse). A larger gift will simply count against your $1 million lifetime gift-tax exemption, so you still may not have to pay gift taxes, says Morristown, N.J. financial planner Chris Cordaro.
- He’s just shy of 20%. If your child has, say, $38,000 to put down on a $200,000 home, kicking in a couple thousand dollars means he won’t have to pay for private mortgage insurance.
- You can have an open family discussion. Your other kids should know that you are providing this aid, whether you intend to help them in a comparable way, and if not, why you made that decision.
How to do it
Today’s tighter lending rules mean your child must be able to prove he’s had the funds in the bank for at least 90 days before he applies for a loan. If you don’t want to hand over the cash that early, be prepared to show that you’ve had the money in your account for at least 60 days.
The bank wants to make sure you didn’t borrow on behalf of your child, says Bill Howe, a mortgage broker in Scottsdale. The bank will also require a letter stating that you don’t expect the loan to be repaid.
Draft a loan if…
- She can pay you back and still qualify for a mortgage. Rules prohibit family loans on the 3.5% down payment needed for government-insured FHA mortgages. For conventional mortgages, lenders typically allow parents to fund only half to three-quarters of a 20% down payment, says San Francisco mortgage broker Edward Craine. The bank will also want your child’s monthly debt payments – including the mortgage, the loan to you, student and car loans, and credit card payments – to be less than 40% of her pretax income.
- You’re prepared to lose the money. Your kid may fully intend to repay you, but her ability to do so could change quickly if, for example, she loses her job or has to move suddenly. “As a parent, you are typically the last one in line to get paid,” says Cordaro.
How to do it
If your child needs only a few thousand dollars, your estate planning attorney can draw up a personal-loan agreement. Or use a lending website such as virginmoneyus.com (cost: $100 and up).
For a larger loan that would allow your kid to deduct the interest, get a formal mortgage (at least $300). You’ll need to pay taxes on the interest you collect and charge at least the IRS’s minimum rate, which changes monthly and runs from 0.35% to 3.35% today, depending on the length of the loan (go to irs.gov and search for “Applicable Federal Rates” – you want to use the plain AFR rate).
Cosign the mortgage if…
- Your child has no other way of getting a loan. Cosigning is risky. After all, you’re on the hook for the mortgage if your child runs short of cash. But it might make sense if your kid is, say, in grad school and already has a job lined up, or has a solid but sporadic income that would disqualify him from getting his loan approved.
No matter how you end up helping your child, keep in mind that your check doesn’t entitle you to pop by Junior’s abode unannounced whenever you feel like it.
Says planner Bergman: “Ultimately it works best if the aid comes with no strings attached.”
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Rory S. Coakley
Coakley Realty, Inc.
20 Courthouse Square, Suite 107
Rockville, MD 20850