For young home buyers navigating a pricey housing market, the Bank of Mom and Dad is open for business.
About a quarter of Gen Z and millennial homeowners received help with their down payment from their parents, according to a LendingTree survey.
Loved ones can help in other ways, but each option comes with its own advantages and possible pitfalls. The key, experts say, is to make sure any arrangement is transparent and addresses potential challenges down the road.
Here’s what to know.
Gifting
The most straightforward way parents can help is to simply gift their children money, either for the down payment or the entire purchase price.
“That’s the only thing that’s clean cut,” said Mark Sanaiha, founder of Macallen Capital in Phoenix.
Government-backed mortgages allow gift funds, said Scott Sheldon, branch manager at SecurityNational Mortgage Company. Still, there are rules. For a down payment, the parents and the adult child must declare in writing to the child’s mortgage lender that the funds are indeed a gift—and not a loan.
“If you all decide later on after you buy the house that the child wants to repay you…I am not part of that,” Sheldon said.
After signing the gift letter, the down payment funds should be wired directly to escrow. Otherwise you will need to do a lot of work to create a paper trail so the bank complies with federal regulations.
Tax documentation also may come into play if the gifted amount exceeds the annual gift tax exclusion. That’s $19,000 this year per donor per recipient.
Be the lender
Another option is to provide your child an intrafamily mortgage, potentially at a rate lower than market rate. That way, he or she still builds equity and creditworthiness and can take the mortgage interest deduction if applicable.
As for you, you get a secured investment at a decent interest rate, with regular monthly payments.
“The parent may need to possibly adjust their asset allocation for the rest of their investments,” said Michael Whitty, an estate planning attorney at Smith Gambrell Russell in Chicago, who is also a certified financial planner. “Because now they’ve got this one big fixed-income investment that they didn’t have before.”
To keep everything on the up and up, Sanaiha recommends using a company like National Family Mortgage for intrafamily loans. The company handles structuring the loan, the promissory note and payment tracking among other documentation.
“It’s very simple for clients to understand, and this matters a lot for audit-proofing the actual transaction,” he said.
Still, this arrangement can backfire if the child misses payments, due to a job loss or divorce.
Parents need to consider how they might handle delinquency, Whitty said. Will you offer forbearance? Are you willing to ultimately foreclose on your child if payments don’t resume?
“Any parent who’s going to be the lender needs to be prepared for that possibility and not freeze in the headlights when it happens,” Whitty said.
Cosign with your child
If your child can’t qualify for a mortgage on their own, another option is to cosign the loan. This also means your name would be on the property deed. To do this, get ready to provide a lot of documentation.
“It’s the whole nine yards,” Sheldon said, including pulling credit scores and documenting income such as pensions and Social Security.
The biggest drawback to this arrangement is, again, if the adult child doesn’t make their payments. A cosigner and their credit score is then on the hook.
Lay out ahead of time with your child a potential agreement if he or she can’t make a payment. How long will you cover the payments? Your child should also have sufficient emergency funds in case the unexpected comes up.
Another way to minimize that risk is signing on as a guarantor on the mortgage, rather than the cosigner, Whitty said.
“There’s no recourse against the guarantor until the mortgage is subject to foreclosure,” he said.
Buy it and lease it
The last option is to buy the property yourself and rent it to your child. While this provides housing, it doesn’t help your child build credit or home equity.
The arrangement can work well if the child needs housing for the short term, like while he or she is in graduate school. After that, you can rent the property to other tenants.
Should you even help?
All these arrangements hinge on the security of your finances and relationship with your child—and any other children.
Even if you want to help, don’t stretch financially, said Thomas Ravert, a certified financial planner with Pathway Capital in Nyack, N.Y.
Never dip into retirement savings, he said. Any funds for a child’s home purchase should be from the parent’s investment account or regular savings.
“You just can’t put your future at risk, because you want to do something nice for your kid,” Ravert said.
You also don’t want to jeopardize your relationship with your child or your other children. Keep in mind what your other kids may expect later if you help out their brother or sister. And go in eyes open if you’re helping a child who has historically been financially irresponsible.
Last, make everything official, so there’s no confusion.
“Put it in writing and be gentle,” Ravert said. “But be honest.”
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