How Parents Can Help Their Kids Become Homeowners
Your children fled the nest years ago, but they’re still living under a roof owned by someone else. As a parent, you want your kids to enjoy the comfort and stability of owning their residence, not to mention a source of wealth that homeownership can bring. Unfortunately, their current financial situation won’t allow them to achieve this without assistance from you. Find out what you can do to help them secure this component of the American dream without risking your dreams of retirement.
- The state of millennial homeownership
- What to know about helping a grown child buy a house
- Tips for parents
- Tips for grown children
- When is it a bad idea to help a grown child buy a house?
The state of millennial homeownership
“What we’re seeing today is that about a third of first-time buyers did receive a cash transfer from a friend or family, which is likely their parent,” said Jessica Lautz, director of demographics and behavioral insights at the National Association of Realtors.
In 2017, millennials made up the largest share of homebuyers. Of this group, 65% were buying for the first time, according to the 2018 National Association of Realtors Home Buyer and Seller Generational Trends Report, co-authored by Lautz. Nearly one-quarter — 24% — of these buyers 37 and younger cited saving for a down payment as the most challenging part of purchasing a home. Student loan debt likely plays a role in this, as 46% of buyers in this demographic are still paying for school, owing a median balance of $27,000.
Millennials are making up for lost time. The homeownership rate for those younger than 35 was 36.8% in the third quarter of 2018, compared with 64.4% for all Americans, according to U.S. Census data. These younger adults had the lowest rate of homeownership, but the percentage does mark a slight increase from 35.6% at the same time in 2017.
One of the reasons adults younger than 35 aren’t forming households at the level of previous generations is likely because more are attending college and graduate school rather than getting married and having children, according to the Joint Center for Housing Studies for Harvard University. Exorbitant real estate costs could also be a factor, considering only 31% of adults ages 25 to 29 head households in the nation’s 25 least affordable metros, compared with 41% in the 25 most affordable metros.
What to know about helping a grown child buy a house
With the economic decks stacked against many millennials, you may be thinking about helping your adult child buy a home. But there are a few things you should know before writing that check. Learn more about the different ways to provide assistance, as well as the pros and cons of each.
Cosigning a loan
The cons. “Parents cosigning on a loan can be liable for the loan in the event the child does not make the loan payments,” said Shirlee Gordon, an attorney specializing in real estate law at Olshan Frome Wolosky LLP in New York City.
And if the payments aren’t made, the parent’s credit will be at risk, said Levi Sanchez, certified financial planner and co-founder of Millennial Wealth, a Seattle-based financial planning firm that works with clients across the country.
“It offers advantages to the child, who may not have the credit history established to qualify for a loan,” Sanchez said. “However, it doesn’t necessarily have any advantages for the parent, unless the child is on time with their payments every month, which could have a positive effect on [the parent’s] credit score.”
There are also legal ramifications. Beyond the financial obligation of cosigning the loan — the lender will look to you if your child stops paying — you could face legal consequences depending on how your name is listed on the property title. You may be listed as tenants in common or joint tenants with right of survivorship, each with its own consequences when one of the owners dies. It may be a good idea to create a co-ownership agreement.
The pros. On the plus side, agreeing to cosign can increase the chances of your child getting a mortgage and a more competitive interest rate, especially if they have bad credit. When it comes to cosigning, TransUnion recommends comparing the rate your child could get on their own with the rate you can help them secure.
Generally speaking, the credit reporting agency cites family members as a good option for cosigning, but only you can make this decision for your unique circumstances. Be aware that once you’ve cosigned, it’s very difficult to remove your name from the loan. Your child would need to take full responsibility, terminate or refinance the loan to relieve your obligation.
Gifting a lump sum
Giving your child the money for a home might be the simplest way to help them buy their own home.
“Most people think they can only give $15,000 a year to each of their children without paying any taxes,” Gordon said.
She said an individual gift can total up to $15,000 per person in 2018 without filing a tax return.
“However, once an individual gifts more than this amount — which is usually the case when putting a down payment on a home — the parent starts using their gift tax exemptions amounts, which sounds scarier than it is,” she said. “An individual has a [lifetime] gift tax exemption amount of $11,180,000. Married couples can gift double this amount without any tax ramifications.”
If you exceed the $11 million total, you could be taxed up to 40% on the gift. The recipient usually isn’t taxed and doesn’t have to report the gift unless it comes from a foreign source, according to Charles Schwab.
Upsides. By gifting the down payment to your child, the house can be purchased in their name. Gordon said your child can then take out the mortgage and make the payments themselves, which might make them eligible for the mortgage interest deduction — and leave you free of liabilities.
“The mortgage interest deduction is capped now at $750,000 for new homes in 2018,” Gordon said. “The individual who makes the mortgage payments can deduct the mortgage interest on their taxes.”
One of the main advantages of this route is it offers a hands-free way to help your kids become homeowners. Sanchez also noted several other reasons gifting a lump sum of money can be a win for everyone.
“The benefits of gifting early are you can prepare for estate taxes if you’re a wealthy family or individual,” Sanchez said. “You can also help children with their financial goals earlier, rather than waiting until you pass for them to use your assets.”
Many mortgage lenders require borrowers to provide a signed gift letter for any large deposits in their bank account used to fund the down payment on their home, so be sure to provide one.
Gift vs. loan. You could also loan your child money to be used for a home, but be aware that even if you didn’t intend to charge interest, the tax code calls for what’s known as imputed interest anyway. For loans above $10,000, the IRS assumes you are collecting the Applicable Federal Rate, published every month here, which you must report as taxable income.
Financing the house yourself
Sanchez said it’s only wise to finance your child’s house yourself if you want to be responsible for the loan and upkeep on the property. This means parents are landlords to their grown children.
“They’re taking all the responsibility out of the child’s hands and taking it on themselves, which some would argue isn’t a good thing when you’re trying to teach your kids good money habits and responsibility,” Sanchez said.
The advantages. The only main advantage of this situation is you’ll be making payments to the mortgage lender instead of your child. If you don’t want to put your credit on the line as a cosigner or aren’t sure they can keep up with the monthly payments if you gift them a lump sum of cash, this could be the best option.
Tips for parents
If you’re going to help your child buy a home, Sanchez advised keeping them involved in the process. He said they need to understand the gift you’re giving them — if you’re getting the loan and buying the house on your credit — and they should learn about the process of getting a mortgage, buying a home and the importance of making monthly payments toward the loan.
“Helping with the down payment might be better than a long-term commitment,” said Tendayi Kapfidze, chief economist at LendingTree.
Of course, direct financial assistance isn’t the only way to help.
“One in 5 first-time homebuyers are moving directly from [a] parent’s home into first-time homeownership,” Lautz said.
She said one big way that parents can help their children become first-time homeowners is by allowing them to live with them.
“It seems very common today,” Lautz said.
She said living with parents gives adult children the chance to boost their credit score, save money for a down payment and otherwise get their finances in order. This allows them to get to a place where they can buy a home on their own.
Lautz noted that all families are different, so this might not work for everyone.
“Go into that situation with your eyes open,” Lautz said.
She acknowledged that having grown children move back in could have financial implications on the parent. Before agreeing to this setup, she advised parents to have conversations with their children and discuss any financial obligations they would need to meet while living under their roof.
Lautz said housing affordability is becoming out of reach for many Americans — especially first-time homebuyers — so this is a way parents can help without actually giving money.
Regardless of the route you take in helping your children buy their first home, don’t dip into your retirement funds. Any assistance you provide should come from extra cash you can spare, not money you’re relying on to ride out your golden years.
Tips for grown children
If your parents are helping you buy a home, Sanchez recommends accumulating cash in a high-yield savings account to prepare for a down payment.
“You don’t want to invest the cash with a short time frame and expose it to market risk,” Sanchez said. “If you need the cash within the next two to three years for a down payment, you’re better off just holding cash or some form of [certificate of deposit].”
Beyond the initial costs of purchasing a home, it’s important to make sure you can handle the expense for the life of the mortgage.
“Don’t overextend yourself,” Kapfidze said. “It’s better to budget on your own income and live within your means.”
Two factors that will largely impact your monthly payments are:
- Down payment
- Credit score
More than half of renters blame a lack of funds for a down payment as an obstacle to homeownership, according to the Urban Institute. The majority — 80% — of consumers either didn’t know how much lenders required for a down payment or thought all lenders required a down payment of at least 6%.
The truth is, different types of mortgages come with different down payment requirements. For example, Fannie Mae and Freddie Mac — the government-sponsored organizations that back most mortgages — offer loans that require first-time homebuyers to put down just 3%, no matter their income. If you put down less than 20%, you’ll probably be required to pay an additional cost for mortgage insurance. As long as you can afford the added cost, this is typically a good move, especially if you don’t have the funds for a 20% down payment.
As for your credit score, you’ll need a minimum of 500 to secure a mortgage. If your score is above 680, you’ll get better rates. With that said, the average first-time homebuyer has an average credit score of 709.8, according to the Urban Institute.
You’ll also want to choose a house you plan to stay in for at least three years — preferably a minimum of five years — due to the high costs of buying and moving. Consider a fixer-upper in your target neighborhood so that you’re in the right location. Find a savvy real estate agent who will help you save money and comparison shop to find the best possible mortgage.
When is it a bad idea to help a grown child buy a house?
“Before helping a child buy a house, make sure they have good financial habits,” Sanchez said. “If they haven’t improved bad habits or behavior before, they’re not likely going to when you help them buy a house.”
If they’re not making payments or are hurting the value of the property, he said this will likely cause stress on family relationships.
“The adult child needs to be in a situation where they can pay for the mortgage themselves at the end of the day and keep up with unexpected costs,” Lautz said.
Besides having the money to pay the mortgage and possible homeowners association costs, she said adult children need to have enough in reserves to cover unplanned expenses, such as a water heater breaking.
Don’t worry if you don’t have the extra cash to help your kids buy their first home or aren’t comfortable serving as a cosigner on their loan, because there are other options. Many local municipalities across the U.S. have down payment assistance programs, including 0% interest loans and grants. For example, New York City’s HomeFirst Down Payment Assistance program offers qualified homebuyers up to $40,000 toward the down payment or closing costs on a house in one of the five boroughs. Many programs are directed toward first-time buyers, so contact the housing finance agency in your state for more information.
The bottom line
You want your children to have everything in life, including a home of their own. If you have the means and desire to assist with this in any way, your generosity will certainly be appreciated. Just proceed with caution. The last thing you want is for your help to cause a rift in the family. So there’s no confusion, get all arrangements in writing and make sure everyone is on the same page from the start to avoid hurt feelings on either side.