Many young adults dream of making the switch from renting to owning a home. When these aspiring homeowners are also your kids, it's only natural to want to help. After all, it's what parents do. Fortunately, there are many options available to help accommodate student debt obligations and to help improve their credit, if needed.
The Bank of Mom and Dad
Before offering to help, consider where the money would come from and have a conversation with your financial advisor about the long-term impact this type of assistance might have on your own financial well-being and retirement plans.
Also, consider the ramifications for the rest of your family. Offering to help one child may lead to similar expectations down the road from your other children. Determine how much you can afford to help in total before making promises to any one individual.
Ways to Lend a Financial Hand
Once you do decide that you can afford to help, there are several options available to you for doing so. However, each may have tax and legal consequences for both you and your child. These decisions require careful consideration before you determine which is the right choice for your situation.
Gifting. When cash is readily available and your child qualifies for a mortgage, but is struggling with saving for a down payment, you can simply give them money. Individuals can give up to $15,000 a year (as of 2018) to any other individual before the IRS requires the payment of gift taxes. This means each child can receive up to $30,000 in combined gifts from mom and dad without tax consequences to either the giver or the recipient. Since the child’s spouse can also receive a similar gift from you, that can boost the amount to $60,000 in a single year.
As part of the mortgage process, however, any gifts will require documentation in the form of a letter from you. The letter will simply state that the sum was, in fact, gifted and is not an interest-free loan.
Family loan. Lending money is another way to help. However, even family loans need to be documented, along with their terms. This would include the payback schedule and interest amount. The IRS requires a minimum amount of interest and sets the rate.
You will be required to file an extra form with the IRS each year that records the interest you received from this loan, which is generally treated as taxable income. Having this loan, however, will negatively impact your child’s debt-to-income ratio, which factors into the mortgage-approval process if they will still need to apply for a mortgage.
Partnering up. Another option is to become joint owners in the home and cosign the mortgage to purchase it. From your perspective, you are responsible for the entire loan should your child be unable to make the payments. As long as they do make the payments, your child would have access to any available mortgage interest deduction, which would help them build a strong credit history.
Equitable ownership. With this option, you would make the purchase and arrange any necessary financing in your name. However, your child would occupy the home, maintain it, and pay all related expenses, including the mortgage, which they would pay directly to the lender. This would allow them to build equity and credit in their own name.
Get Professional Advice Before Acting
Again, before determining how you want to help, discuss the tax ramifications of each option with your financial advisors. Recent changes in the tax laws, especially those regarding the deductibility of mortgage interest and property taxes, could influence your decision.
It's always a good idea to get a professional's opinion. Talk with a loan consultant about the different options you may have with your situation.