Helping Your Child Buy a Home

Make sure you don’t jeopardize your own retirement, experts warn, and be aware of all the options for gifting or loaning.

Make sure you don’t jeopardize your own retirement, experts warn, and be aware of all the options for gifting or loaning.

You watch as your adult child struggles to make a living. He’s paying a lot of money to rent what seems like a crummy apartment but can’t afford more because of his big student loan debt. His career is promising, but he’s still on the bottom rung of the corporate ladder. When he marries, he and his wife start looking for a home in which to raise a family, but housing prices are high. You want to help, especially while mortgage rates are low, but is it a good idea, and what are your options for lending a financial hand?

Financial experts say to first consider whether you can afford to help. That is, do you have enough for your retirement, or will giving or loaning your child the down payment on a house delay your own retirement plans? While your children will have time to accrue money over their lifetimes, whether with their investments, jobs or home equity, you don’t have the luxury of time. Studies show that parents 65 and older who financially support their kids are much less likely to be retired than those who don’t.

Before making a decision, talk to your financial adviser about whether you can afford to make a sizeable gift to your children. Also, either gifting or loaning money for a house can have serious tax consequences. Your Certified Senior Advisor can also provide advice. Before you decide to help your son or daughter, make sure you are aware of all the different options for doing so.

As a Gift

The easiest way to help is to give money as a gift, usually in the form of paying for the mortgage deposit (usually 20 percent of the home price) or closing expenses. But whether this is the best route depends on several factors. Experts talk about the responsibility aspect. Has your child asked you for money every time a problem came up in their life? Or is she someone who has worked hard and taken responsibility for herself, but just needs a boost to get to the next stage of life? Giving money to someone who has been irresponsible most of their life may only contribute to that pattern and won’t help either of you in the long run.

Make Sure to Protect Yourself

Mortgageloan.com suggests a few basic rules for parents to follow when helping their adult children buy a home:

• Don’t borrow against your home or retirement funds.
• Use cash accounts. Don’t liquidate your investments.
• Don’t establish a joint account with a child.
• Avoid cosigning for a credit card or a loan with a child. If the child defaults, your credit score is damaged and the bank comes after you.
• If you do end up cosigning, at least take the title to the property as well. That way you own the house if the child defaults and you can recoup the investment by selling or renting it.
• Keep the process as businesslike as possible and set up realistic payback terms from the start. Spell out your expectations and your child’s responsibilities ahead of time to avoid ugly misunderstandings later.

Besides the emotional issues are the financial consequences. The Internal Revenue Service (IRS) allows an annual gift tax exclusion of $14,000 per recipient per year. However, a married couple could each give $14,000 to a child and a child’s spouse, for a maximum of $56,000 in four separate gift checks. Be aware that gifts of more than $14,000 per parent to one child in a given year could count against the parents’ lifetime gift-tax exemption of $5.45 million, resulting in higher taxes on the eventual inheritance of large estates. On the other hand, giving the maximum or less allows parents to give away some of their estate while they are living, which can reduce estate taxes later.

A lender needs to make sure that your gift isn’t a loan, which might disqualify your child for the mortgage loan (because it would add more debt to the mortgage holder). Therefore, you need to provide a letter signed by you and your child, listing the amount and transfer date of the gift and stating that you don’t expect repayment.

An online retirement calculator (such asBankrate) can help you estimate how a gift would affect your retirement savings.

As a Loan

Although lending your child money to buy a house might seem the best choice if you need to preserve your retirement funds, a loan can come with messy emotional costs. You’ll need to sign documents coming up with a repayment plan (for the IRS as well), which means at some point your children will need to pay you back. When that time comes, especially if your children are unwilling to pay, are you willing to take your children to court? On the other hand, parents who don’t want to give their children the money outright, because they worry that it would encourage financial irresponsibility, can provide the loan and later forgive the debt if their children are making all the payments on time. It can be a way for parents to ensure that their children are taking some responsibility. A loan, rather than a gift, can also quell any sibling resentment over unfair treatment.

One advantage of loaning money is that parents can charge a higher interest rate than they would get on a CD, but less than it would cost their child to get a mortgage. Financial experts warn that when lending your child money, consider first whether you can afford to lose that money forever, in case your child can’t pay it back.

Because IRS deems the interest payments as income, the tax agency will require you to charge a minimum interest rate, with ensuing penalties if you don’t. In any case, you should discuss the tax and financial consequences of this option with a financial adviser or lawyer before entering into a loan agreement with your child.

As a Shared Deal

A good alternative to either giving or lending the money to your child is to share the home cost. In a shared-equity deal, the parent and child jointly purchase a home and decide on splitting the title 50-50 or a different percentage, depending on each party’s needs. While both contribute to the home’s cost, upkeep and taxes, one advantage is that your son or daughter gets a bigger home than they would have qualified for on their own. Your child could rent out bedrooms in a larger home, providing you both with rental income. Another benefit of this deal is that the child doesn’t need to use all their money for the down payment, while the parent can profit when the property sells. And because a shared-equity deal is classified as a residential loan, it has a lower interest rate than a rental property.

Other Alternatives

Cosign the mortgage. While some adult children may have enough money for a deposit on a home, a bad credit history may make them ineligible for a mortgage. In this case, parents could cosign the loan, thus guaranteeing that they will make the payments if their son or daughter can’t. But many financial experts advise against this because of the danger of parents taking on a huge debt burden in or close to their retirement years. Only do this if you are confident your child will be able to make the payments.

Buy the home. If you can afford to pay for the home outright, you can either give it to your child or have them pay rent. This could be a good option if your son or daughter is not currently prepared to take on a mortgage but may be more able later down the road—after they graduate, for example, or become more established in their career. This has the advantage of locking in a good deal on a home while mortgage rates are low, especially if you believe housing prices may increase in your area. The rent you charge would likely be less than what your child is paying to their landlord.

However, because of IRS rules, you would likely need to pay the 35 percent gift tax, although there may be tax strategies to get around this. As a landlord, parents can deduct property tax payments, maintenance and repair costs, depreciation expenses and mortgage interest.