Parents: How To Help Your Adult Kids Buy A Home
Young adults buying their first home face some special challenges today – the economy has not been kind to Millennials.
Record-setting student debt, entry-level wages and high rents make it hard to save a downpayment or qualify for a home loan.
The good news is that today’s mortgage market allows concerned parents to help.
Lending agencies have written guidelines to address this exact situation.
Sharing Your Assets And Credit
There are several ways parents can help their adult children achieve homeownership, depending on their resources, and how much they want to be “on the hook” for their kids.
You can choose to loan your kids money for the downpayment and closing costs, or even the entire purchase price. You can co-sign for them, or co-borrow with them.
Alternatively, you can help them qualify for financing on their own.
You can help kids improve their credit scores by adding them to your credit card accounts. The accounts must have a good payment history. Note that your kids don’t actually need to use the credit or even know what the account numbers are to benefit from this.
You can increase your children’s reserves by putting their names on your bank accounts. It’s best if you do that two or three months before they apply for a loan, and you’ll have to sign a letter stating that the kids have joint ownership of the funds in the account.
Co-signing can help your adult child qualify for a home loan if his or her debt-to-income ratio is on the high side. For most mortgage programs, though, having a co-signer cannot offset a poor credit rating.
That’s because when multiple parties are involved, the lowest credit score drives the underwriting decision. However, there are portfolio or “Non-QA” lenders that allow credit scores as low as 560 with a co-signer.
There are disadvantages to being a co-signer, though.
First, you have no ownership interest in the property, but you’re on the hook if the borrower fails to repay the loan.
Second, if the borrower misses a payment or pays late, this affects your credit history and score.
Third, co-signing creates “contingent liability,” which means many lenders will consider your child’s mortgage payment in your debt-to-income ratios, which can make it difficult for you to qualify for financing.
It’s generally better to be a co-borrower than a co-signer.
Co-borrowing offers you the protection of an ownership interest in the property. As a non-occupant co-borrower, your income and assets are considered in the underwriting decision.
You are liable for repayment of the loan if your child defaults, and the loan payment history will probably show up on your credit report.
There are several ways to structure a co-borrowing arrangement.
- Add your name to the loan and let your child make the downpayment and payments
- Pay part of the downpayment and / or monthly expense in exchange for some ownership
- Make the monthly payments to the lender and receive monthly payments from your child
The last option is a good solution if you’re worried that your child might harm your credit rating.
Co-borrowing arrangements should be spelled out in advance, in writing, and signed by all parties. You may want to have yours drafted by an attorney.
Another option is to gift some or all of the downpayment and closing costs to your child.
There are several loan programs that require downpayments of just five, three or even zero percent. Many of these programs allow the entire downpayment to be gifted.
If you can afford it, you may want to help your child avoid mortgage insurance by gifting enough to make a 20 percent downpayment.
However, larger gifts could trigger a costly gift tax — check with a tax pro before making a gift exceeding $14,000.
When gifting money to your children for a home purchase, it’s crucial that you document several things:
- You have the money to give, and it did not come from an interested party to the transaction
- The money is a gift, not a loan. The lender can help you draft a gift letter.
- The money transfer is complete
You can make the transfer directly into the escrow account, or you can submit paperwork showing the transfer from you to your child.
With some advance preparation, you can simplify the process by adding your child to your own account a couple of months before the purchase. He or she can then simply withdraw the downpayment prior to closing.
Loans To Your Kids
You can loan your kids some or all of the downpayment, or even money for the entire purchase.
You’ll definitely want a written, signed agreement for this. It should state the terms of the loan — interest rate (if any), payments, due dates, etc. You may choose to have you child make regular payments to you, or you may choose to have the entire balance due and payable when the home is sold.
If you lend the downpayment several months in advance of the purchase, your child would place the money in his or her bank account and count it as an asset when applying for the mortgage.
The monthly payment to you would be disclosed to the lender and included in the debt-to-income ratio.
If you lend the downpayment at the time of purchase, it must comply with the lender’s guidelines.
A loan from you can help your child avoid mortgage insurance – for example, an 80/10/10 is an 80 percent mortgage from the lender, a ten percent loan from you, and ten percent from your child.
Avoiding mortgage insurance would allow your child to qualify for a larger loan and a better house.
Buying The Home For Your Child
Another solution is to buy the property outright and draft a rent-to-own agreement with your child.
In this way, the property provides an investment for you today, and a future ownership opportunity for your child.
The Shared Equity Financing Agreement (SEFA) is a popular arrangement for family real estate purchases. You and your child would purchase property together, with you being the owner/investor and your child the owner/occupant.
The ownership interest, downpayment and monthly expenses would be split between you, and your child would pay a market rent. When the property is sold, the profit would also be divided.
For instance, Mr. and Mrs. Jones enter a SEFA with their daughter, Sarah, to buy a $300,000 home. The Jones’ put up $30,000 and Sarah puts up $30,000, and they finance $240,000.
They split the monthly payment ($539 each), and the taxes and insurance ($111 each), for a total of $600 a month.
Sarah rents half the home from her parents. The market rate for the entire home is $1,000 a month, so she pays $500.
Her total monthly outgo is $1,100, and her parents pay $150 after receiving her rent.
Both parties split the tax deductions equally.
If the property appreciates by five percent a year, in five years it will be worth $382,884. They can sell it and split the profit 50/50.
Equity can be shared in any proportion, for example 60 / 40 or 90 / 10, depending on the parents’ and child’s resources.
Situation To Avoid When Helping Adult Children Buy A Home
Family and finances can be very complicated. You have to balance your child’s needs with your own to protect your relationship as well as your retirement and estate.
To avoid potential hard feelings, many experts recommend that parents provide gift funds rather than loans.
They also don’t advise co-signing, because the potential downside is huge and your control is almost non-existent.
If your assistance to your child is an advance against his or her inheritance, and if there are other children inheriting, prevent litigation between your kids by making your wishes very clear, in writing.
Finally, follow these basic rules for any sort of assistance you want to offer:
- Don’t borrow against your home or retirement funds
- Avoid liquidating your investments
- Avoid cosigning for a loan with a child; co-borrowing allows you to take possession of the property if the child defaults
- Keep things as businesslike as possible with affordable repayment terms and consequences for default
- Do not use gifts to control your child; that’s a good way to damage your relationship
By following a few sensible rules and keeping things as businesslike as possible, you can safeguard your money and your relationship with your family.
What Are Today’s Mortgage Rates?
Helping your child afford a home today is easier because of affordable mortgage rates. Programs like 5/1 ARMs offer lower rates that are fixed for a number of years, keeping payments low during your Millennial’s early earning years.