As we have seen, the rent in many cities has continued to increase over the past few years, and Boston has been no exception. Per rentcafe.com, the average cost of rent for an apartment in Boston increased from $2,758 back in January 2015, to $3,001 in July 2018. One could pay a comparable amount as a mortgage payment and be building equity. Parents have often helped their adult children with the finances in the purchase of their first home. With the impacts of the recession, current job market, and the effects of accumulating student loans, it has been more difficult for many millennials to come up with the funds to purchase a home. This is where parents may generously step in to help, especially with the down payment. Before jumping in to help with a purchase, it’s important to understand the different options and the ways they will impact you and your child. Speak with a financial advisor who can provide guidance on what is feasible and also have your child speak with an advisor too to determine if he/she is able to to cover a monthly mortgage payment, taking into account other financial obligations.
Gifting the Down Payment
The most common way parents help their child purchase a home is to put up the money for the down payment. Down payments can commonly reach up to 20% of the purchase price though there are programs for first time home buyers where less of a down payment may be required. While your child may be able to swing the monthly payments, having sufficient funds for the down payment can be the tricky part. Parents that can cover the majority, or even the entire down payment may gift the money to their child and file a gift tax return. You will need to document and verify with the mortgage lender that the money is in fact a gift, and not a loan. A loan would add to your child’s debt load, and could disqualify him/her from securing the mortgage. Consult a mortgage lender and make sure to keep track throughout the process.
If you want to help your child with a down payment but will eventually expect repayment, you can loan the money. The mortgage lender and the IRS will require you to formalize the loan and submit the required documentation along with it. As the lender, you set the terms of the loan; however, the monthly payments in addition to all other outstanding monthly debt repayments such as student loans or credit cards can not surpass the mortgage lender’s maximum debt-to-income ratio. You will be required to establish a repayment schedule, charge an interest rate (IRS requires the minimum), and report the interest as income on your taxes. Again, consult a mortgage lender on your options.
For some millennials, it’s not necessarily the high cost of the down payment that prevents them from purchasing a home, but rather getting approved for a mortgage. If your child has any negative hits on his/her credit score but is otherwise financially healthy, pursuing a joint mortgage might be the best option. Different loans are available (Fannie, Freddie, FHA) which all carry different requirements for the percentage minimum a parent must put down for the home. If the parent does not put down the required minimum, the property would be considered an investment. Investment properties impose a higher interest rate than traditional joint mortgages. Joint Mortgages should only be pursued if the parent has 100% confidence that his/her child can and will make their monthly payments on time. Failure to do so could negatively impact a parent’s credit score, or result in a lien against the property. Again, consult a mortgage lender if a joint mortgage is right for you.
Buying to Rent
An alternative approach we are seeing is some parents are opting to purchase a home outright for their child and collect monthly rent equal to the mortgage costs. This would be classified as an investment property. This is a great method for some parents because it leaves them in control. Some parents eventually allow their child to purchase the home as his/her own with the equity they have built through rent. In this case, parents will not sacrifice their own retirement funds or potentially damage their credit.
An alternative to gifting or loaning money is for parents to help their adult child with other expenses to allow him or her to save for a down payment on a home. Covering your child’s expenses such as utilities, rent, food, or allowing him or her to move home will expedite saving for the down payment. It will certainly be a lifestyle adjustment (for everyone!) but this will reduce your child’s expenses significantly, freeing up money that ultimately could be put towards the purchase of a home.
The challenges of first-time home buying can be tough; a parent’s help makes a world of difference. The options I referenced may make it possible to help your child achieve the milestone of home ownership. Remember to consult with a financial advisor to ensure you can comfortably afford to help in whichever way you choose. Then, make sure to work with a trusted, experienced real estate broker and advisor to navigate the process and achieve the best result. If you want to learn more, discuss helping your child purchase a home, or to view property options, call or email me and lets get the conversation started!