Young adults aren’t just borrowing from banks to buy their first homes—many are asking for help from mom and dad. The median US home price surged above $400,000 in 2021. And a 2019 survey found that 43% of homeowners younger than age 35 received financial help from their parents, and more than half of would-be homebuyers in this age bracket expected to get such support.
But there’s a dark side to this assistance: Many parents put their own retirements at risk when they help kids buy homes, and, counterintuitively, this aid sometimes damages parent-child relationships. Here are strategies to help your kids without blowing your retirement…
Strategy #1: Gift money to help with the down payment. A 20% down payment on a $400,000 home is $80,000. A cash gift from a parent can be a big help, and no-strings-attached gifts are less likely to have unforeseen financial consequences than most of the alternative strategies that follow. Still, there are details to consider…
If you have more than one child, gifting a large amount of money to one could create family disharmony. Potential solutions include gifting money to the other kids, too, if you can afford to do so…or adjusting your estate plan so that your kids receive equal amounts in the end.
Your child’s lender likely will insist that you sign a “gift letter.” This letter should state that you gave the money free of any encumbrance. In other words—that it is not a loan you expect the child to repay.
Large gifts occasionally have tax consequences—but the limits aren’t as strict as many people think. You might have read that as of 2022, the maximum amount one person can give another without potential tax consequences is $16,000—but there are ways around this. Examples: If you’re married, you and your spouse each can give $16,000 to your child…and if your child has a partner, you and your spouse could each give your child and his/her partner $16,000, boosting the total no-tax gift cap to $64,000. And even if you do exceed the annual cap, it won’t necessarily result in a tax bill—the excess will count against your lifetime gift-tax exemption, which is $12.06 million. This exemption changes over the years, but unless your estate is well into the millions, federal gift taxes are unlikely to affect you. Speak with your financial or estate planner for details.
Is this strategy right for you? Cash gifts are the most straightforward and often the best—assuming that you have the means to give a sum of money without risking your own retirement. Choose an amount that fits into your financial plans even if it’s only a fraction of what your child needs—it’s better for your child to save a little longer before buying a home than for you to outlive your savings.
Strategy #2: Loan money to the adult child. A loan might seem like the sensible solution if you have sufficient savings to help your child with his/her down payment but you eventually need that money back for your retirement. Two big drawbacks…
You might not get the money back. Many intrafamily loans are never repaid—a 2019 survey reported that 37% of these loans resulted in financial losses for the giver. Moreover, tensions triggered by intrafamily loans damaged 21% of giver-recipient relationships.
An intrafamily loan could make it harder for your child to get a mortgage. Your child’s “debt to income ratio” is among the key stats that lenders will evaluate when deciding whether and at what rates to offer a loan. The money you lent your child will increase his debt.
Is this strategy right for you? Only if you cannot afford to make this money a gift…and you have confidence that your child will repay you…and this loan would not inflate your child’s debt-to-income ratio to levels that lenders might consider problematic. An online mortgage calculator such as HSH.com’s “Home Affordability Calculator” can help determine whether this might be a problem, or ask a mortgage lender or broker.
If you do lend money to your adult child: Put the loan terms in writing, and charge sufficient interest so that the IRS accepts it is a loan and not a gift. As of February 2022, rates as low as 0.59% were acceptable for loans up to three years…higher minimums applied to longer-term loans. Enter “Index of Applicable Federal Rates” into a search engine to find the minimum rates for the month when the loan is made.
Strategy #3: Let your child live in your home rent-free while he saves for a down payment. If you have more free space than free cash, inviting your child to temporarily move in could help. If this saves the child $2,000 per month in rent and utilities, that’s the equivalent of a $24,000 gift each year.
The downsides here are relationship related—not every parent and adult child could live under the same roof without getting on each other’s nerves.
Is this strategy right for you? It could be if you have the space and everyone enjoys living together. Discuss the details before it begins to reduce the odds of problems. What house rules would you request? How would household chores and expenses be divided? Is there an end date by which you would expect the adult child to move out?
Strategy #4: Co-sign the adult child’s mortgage. Adding your name to a child’s mortgage application could help him qualify for a loan—lenders will take your credit score, assets and income into account as well as your child’s. When co-signing goes well, it’s a way for parents to help their kids buy homes without handing over any cash—but it doesn’t always go well for the following reasons…
Co-signers have a legal obligation to make mortgage payments if the primary borrower fails to do so. You could end up saddled with a long-term financial obligation for a home you don’t own.
Co-signing could damage your credit score, particularly if mortgage payments are late or missed. That could make it more expensive for you to borrow if, for example, you later wish to refinance your own mortgage or obtain a car loan.
Is this strategy right for you? Only if your credit score is significantly higher than your child’s—otherwise adding your name to mortgage applications won’t sway lenders—and only if you are very confident that your adult child will make his mortgage payments on time.
Strategy #5: Be a “co-borrower” on the adult child’s mortgage. As with co-signing, this means lenders will consider your credit score and financial picture along with your child’s. But as a co-borrower, you’re not just required to step in if the child misses mortgage payments—you share the primary obligation to make these payments and share ownership of the home. And as with co-signing, your credit score could suffer if your child fails to make his mortgage payments on time—even if you paid your share.
Is this strategy right for you? Only if you’re able to pay part of the mortgage each month and you’re confident that your child will pay his share. This also makes sense if the plan is for you to eventually move in with this adult child.
Strategy #6: Buy a home, and rent it to the child. This avoids the financial entanglements of co-signing or co-borrowing—the property belongs to the parent. It’s like buying an investment property. But there’s still plenty of room for this to go wrong…
Adding a landlord/tenant component to the parent/child relationship can create family strife. It could undercut your investment, too. Just think—would you evict your child if he didn’t pay the rent?
Investment property mortgages have higher rates and down-payment requirements than those for primary residences.
Is this strategy right for you? Only if you’re looking for an investment property in the area anyway and your child would be a reliable tenant and doesn’t have his heart set on becoming a homeowner. You and your child should discuss how property maintenance will be handled—is this a traditional landlord/tenant relationship where the tenant calls the landlord whenever something breaks…or do you expect your child to handle such things, perhaps in exchange for a below-market rental rate?