Exploring Different Ways You Can Offer Your Financial Assistance
Buying a first home can be an exciting time! It’s something that many people dream about for years, creating an ideal image of where they want to live and what they want in their house. Thinking about neighborhoods and floor plans is a start, but as many first-time homebuyers can attest, the reality of shopping for a home can be very different from what they may have envisioned. Under the best of circumstances, it can be a stressful process. Searching for a place you can see yourself living in, while staying within budget and dealing with the challenges of mortgages, inspections, sellers, and timelines can be overwhelming. Add into that today’s real estate climate, with high mortgage rates and low inventory of homes, and many hopeful buyers are finding themselves struggling to make a purchase. While this may leave some with no choice but to put their homebuying aspirations temporarily on hold, others may have the benefit of assistance from a parent or grandparent, which may make the difference in being able to move forward with a purchase. However, if you are a parent or grandparent who may want to offer help, you’ll want to consider all the factors involved before taking any action.
Is your child or grandchild financially ready to buy their first home?
Anyone who is preparing to buy a home should be financially ready, and that is no different in cases when a grandparent or parent is in a position to help. Buying a house is a huge financial decision and should not be undertaken lightly. Before determining in what way you may want to offer financial assistance, it can be a good idea to have an open discussion about your child or grandchild’s means, goals, and their feelings about the process. Are they buying alone? Or with a spouse? If so, are there two sources of income contributing to the mortgage payments? Is your child/grandchild’s employment secure? Are they planning to start a family? Will this potentially change their income level if one spouse stops working outside the home? Will this home continue to suitably fit their needs for years to come? Or will this be a starter home that they intend to sell within a few years?
Is your child or grandchild ready for this financial commitment? Have they determined their budget by taking into account their credit score, income and debts? A home affordability calculator can be a useful tool to get a clear picture of some of the costs involved in homeownership. Prospective homebuyers should think about how a monthly mortgage payment will fit into an overall financial plan that includes other goals like saving for college expenses or retirement. Once all of these considerations have been taken into account, if you want to help your child/grandchild buy a home, you have several options.
How can you help your child or grandchild purchase a house?
Each of the different ways you can help comes with pros and cons. It’s also important to consider the emotional aspect of money and how your good intentions may still potentially affect family dynamics. You can try to minimize this with clear communication throughout the homebuying process.
- You can give them a cash gift. This may be the simplest way to offer your financial help. Your child/grandchild might have excellent credit and be in a position to manage their monthly mortgage payments without a problem but need assistance in coming up with a downpayment. Typically, mortgage lenders do allow a relative to gift a downpayment, however, depending on the type of mortgage your child or grandchild is taking out, it may come with its own rules. With a standard conventional loan, if your child or grandchild is putting down 20% or more, it can all be gifted. If the downpayment is less than 20%, then at least a portion must come from your child/grandchild’s funds as well. Different rules apply with FHA or VA loans so it’s best that you speak with a mortgage broker to determine how much you can gift.
You will be required to submit a letter stating that the funds are a gift from you and that you do not expect repayment. In addition, you may be asked to provide your own financial proof, such as a bank statement, which shows that you are in a position to gift the money. Banks want to be sure that these funds are not actually a loan which will increase your child or grandchild’s debt and may impact their ability to keep up with their mortgage payments.
In 2024, you can gift up to $18,000 to your child/grandchild without having to file a gift tax return. Married couples can give up to $36,000. If you are able give your child/grandchild cash without expectation of repayment, it can alleviate the potential financial and emotional burden of a loan if unforeseen circumstances down the road were to make it difficult for them to pay you back. You can also make gifts in excess of the annual exclusion amount and file the informational gift tax return.
- You can provide them with a loan. Another option is to provide your child or grandchild with a loan. Even if you are able to gift them the entire amount they would need to purchase the house, you may want to structure it so that you are lending the money at a lower rate than they would be able to obtain through a bank, and still helping them to build personal accountability as they pay off a mortgage. For instance, as of this writing, the average annual percentage rate (APR) for the benchmark 30-year fixed mortgage is 7.25%. According to a Bankrate survey of institutions, as of July 22, 2024, the national average savings account yield was 0.6 percent APY. If you were to provide your child/grandchild with a mortgage at a more favorable interest rate, you would make the path to homeownership more affordable and still earn more on your money than if you kept it in a bank savings account.
It’s important to keep in mind that if you want to offer your child or grandchild a loan, you need to make sure that the rate you give them meets at least the minimum federal rate, which is called the applicable federal rate (AFR). This rate is set monthly and will vary depending on the structure of the loan, specifically the number of years the loan will last and how frequently the interest is compounded. If you do not charge enough interest, the IRS can view the interest you should have charged as a gift.
If you decide to provide your child or grandchild with a loan, clarity in the terms you are offering is key. While we always hope for the best, life can be unpredictable. Just as a traditional mortgage provider may have grace periods and hardship clauses regarding situations when a homeowner may fall behind, you should spell things out in writing so that expectations are clear long before they ever may become a concern. For instance, if your child/grandchild gets sick for an extended time, or loses their job, they may have difficulty keeping up with payments. You may decide to state that, under certain hardship conditions, there is an option to defer up to a set amount of payments to the end of the loan. Or if your child/grandchild’s ability to meet their financial obligation changes, and they fall drastically behind, there may be a need for you to foreclose on the property. These terms should be included in writing.
If you determine that you’d like to provide your child or grandchild with a mortgage, it can be helpful to speak with your financial advisor. They can help you create a plan that suits your specific situation and takes into consideration the tax implications that you might deal with in offering an intra-family loan. A real estate attorney can help you draw up all the necessary documents.
- You can co-sign a mortgage with them. There are different reasons why your child or grandchild might not qualify for a mortgage on their own. They may have a credit or employment history that does not meet a lender’s requirements for approval, yet they still may be capable of making monthly payments. This is a situation you’ll want to weigh carefully before offering to co-sign, as this solution does come with more substantial risk.
As a co-signer, your debts, income, and credit history are factored in alongside with the mortgage applicant’s. If your child/grandchild’s credit profile isn’t strong enough, when the bank adds in yours, it may be possible for the application to be approved and at a better interest rate. However, you are taking on the same risk to your credit as your child or grandchild, and as a co-signer, you will not have any claim to the home that the mortgage is attached to. Essentially, you are offering a lender your finances as a safety net to your child/grandchild’s.
If you choose to help in this way, your credit and borrowing ability can be impacted. As a co-signer, you are taking on this debt as your own, and as a result, it is calculated into your debt-to-income (DTI) ratio which could potentially make it harder for you to qualify for a loan. If there are any missed or late payments, not only is there a chance that the bank will not inform you, but those will show up on your credit score as well. If you are co-signing on a mortgage, you should have your child/grandchild give you access to the account information and the ability to sign into the bank’s online portal so that you can monitor payments. Remember, if your child or grandchild goes into default in making the mortgage payments, you are legally responsible for the debt.
An alternative to co-signing the loan is to become a co-borrower, in which you share ownership of the property. However, this will still come with the risks of hurting your credit if the mortgage is not paid on time.
- You can purchase a home that your child or grandchild can live in, and you can determine the best way to manage this option. Maybe your child or grandchild is just starting out and you don’t feel that they are completely ready for the financial responsibilities that come with purchasing a home, but you want to help them to learn by easing them into the process. Or, they may have struggled with saving for a downpayment while they were paying rent on an apartment, and you want to help them to move into a home they can work toward calling their own.
One option is that you can buy a home that your child/grandchild can rent-to-own with a lease-option agreement. In this case you would draft a formal agreement that outlines an eventual purchase price, the terms of the rental period, and a breakdown of what portion of the rent will go toward them buying the home from you. You maintain ownership of the property for the duration of their renting. This can solve their immediate need for housing and will allow them to build their financial independence and responsibility. Should they need to relocate at the end of the rental period and choose not to exercise the option to purchase the home, you now have the ability to rent to new tenants or sell the property.
Another alternative is to purchase a home that you can gift to your child or grandchild. It would be best to consult your financial advisor before taking this action, as it could have tax implications.
Weighing Your Options
Whether you choose to give your child or grandchild a cash gift, serve as their mortgage lender, co-sign on a loan, or buy a house for them, there are potential risks that should be considered before making a commitment. In addition to financial considerations, there are family dynamics to think about as well. If you have more than one beneficiary, you may want to think about how you can provide balance. Helping your children or grandchildren during your lifetime can give them financial support when they actually need it the most, but you may want to equalize lifetime gifts with future inheritances, so that other family members are not left with hurt feelings or an inequal inheritance.
If you decide you want to assist your child or grandchild on their journey to homeownership, it is a good idea to speak with your financial advisor. Together with you, they can create a plan that is designed to accomplish your goal of helping your child or grandchild while keeping you on track for your own healthy financial future. If you would like more information, please feel free to contact us.
