Spring has arrived, which means For Sale signs for homes start to pop up in neighborhoods as sellers try to sell their homes during the warm weather and blossoming flowers. Even during the current environment home prices continue to command premiums, especially in certain cities and neighborhoods.
We have fielded a handful of calls from parents asking how they can help their children with the home buying process, whether through loans, gifts, or joint title. Each method has its pros and cons, and it is important to discuss each option before making any financial moves.
To start with, lenders will recommend parents “gift” the down payment money rather than loan it. Lenders usually prefer to be the only lender and don’t want to have to complicate the lending process.
But how much to gift? Will the gift be taxable? Taxable gifts are in excess of $15,000 per person per donor. What this means is a mother and father combined can gift up to $30,000 to whomever, including their child, child’s spouse, and grandchildren, without having to pay taxes on the gift. Any gift in excess of $15,000 per person would be taxable but potentially offset by a tax credit, up to certain limits. A gift tax return may also need to be prepared in the year a taxable gift is made even if no tax is due because it is offset by a tax credit.
Loans may also be a good option, especially if the parents plan to help with more than the annual gift limit. However, loans may require proper documentation and a minimum interest rate set by the IRS. The good news is, given the current environment, the applicable interest rate is near historic lows, so the loan route may be the better option in this environment. While the parents would have to report the interest earned on their tax return, they may have
the option to forgive the interest by treating the interest due as a “gift.” Again, the lender may not approve the borrower for the loan if the borrowers have a large loan outstanding to their parents though. So, this strategy should be discussed with the lender during the prequalification phase.
Joint title may help the children qualify for a larger loan since the parents may be more qualified borrowers. However, having multiple owners on title may create future estate issues. Liability must also be considered too, because if any party defaults then the joint owners may be equally liable. It is generally best practice to have ownership reflect the economic reality of the situation. If the children will be living in the house; paying for the mortgage, property taxes, and upkeep, and expect to benefit from any tax deductions related to home ownership, it may be best to have title to the property and the liability of the mortgage loan reflect this.
In all scenarios, it is important to first go through a budget exercise to determine how much the children should spend on a home. If they are over-extended financially even before buying a house, then maybe they should consider buying a less expensive home. Second, it is important to discuss how much is needed for the down payment, how much help the parents plan to provide, and how the gifts/loans may affect the parents’ overall estate plan and any other children and beneficiaries. Third, a discussion of parents’ liability and control should also be considered, ranging from if the children default on the primary mortgage or divorce. Finally, it is important that the parents consider their own long-term financial goals and objectives first to make sure they are in a financial situation where they can help their children with a home purchase without incurring negative long-term financial repercussions.