More parents are helping kids with homebuying. Should you?by Tim Manni
According to Better Homes and Gardens Real Estate, 20 percent of all baby boomers would gift or loan money to their children or grandchildren to acquire a home.
The study said one in five baby boomers has already gifted, loaned or co-signed a home loan for their children or grandchildren. Looking ahead, 68 percent said they would help family members with a down payment if they asked.
The catch is that all assistance is not the same.
In terms of homebuying, a “gift” is seen as something that doesn’t need to be repaid. Mortgage lenders require donors to provide a gift letter which legally says the money is a gift and not a hidden loan that must be repaid. This is a good protection for the recipient in the sense that relationships sometimes “evolve,” and the letter can be used to fend off any future claims by mom and dad if they want the money back.
In addition, lenders will want to assure that:
- The donor is not a seller, broker or builder with an interest in the transaction
- The money actually exists–meaning the donor must provide account information showing where the money is kept and coming from
- There is a canceled check or other form of proof showing the transfer of funds
These “gifts” can make a serious impact for the buyer when it comes to loan qualification. The gift does not increase the borrower’s monthly costs or debts, so the borrower’s ability to qualify for a mortgage is not decreased but rather improved.
Most loan programs now allow what is called a “seller contribution.” The contribution typically can be as much as 3 to 6 percent of the purchase price. However, while a seller contribution can be used to offset FHA closing costs, it cannot be used for an FHA down payment. The down payment has to come from the buyer or to the buyer in the form of a gift that can be used to offset or fully pay the FHA’s 3.5 percent down payment requirement.
A loan from parents is surely helpful, but a “loan” is a loan-the money must be repaid, interest is charged and the existence of the loan must always be disclosed to lenders. Since today’s mortgage rates are so low, it’s realistic for parents to loan kids money at market rates for little cost. For specifics, speak with a tax professional–if the loan rate is too low there could be claims of creating imputed–and taxable–income.
A loan from parents and grandparents–just like a loan from any source–always impacts mortgage qualification benchmarks because it is an obligation to be repaid as well as a monthly cost.
When parents and grandparents choose to co-sign a home loan, the new mortgage will be acquired at least in part through the good credit of a financially established family member.
Parents who are thinking about becoming co-signers should realize that if their child does not pay off the debt, the lender will look to them for full repayment. Also, co-signing with one family member may impact the credit of a parent or grandparent and therefore limit their ability to co-sign for another family member in the future.
Lending your kids money to buy their home is a grand gesture—just make sure you understand all that comes with it.