By Michael Edlen
It is well known that purchasing a home in the Westside housing market is very challenging, especially if it is a first home. And in recent years it has gotten even harder for young families with growing student debt and a slowly recovering job market.
In many areas of the country there are some options for funding a purchase. These include FHA or VA loans, programs for teachers, etc. Although these programs are not very helpful in most of the Westside because of the price ranges, there are several ways that parents (or grandparents) can assist children in becoming homeowners. If families step in early to help their adult children with a first home, it may give an opportunity for key life lessons and include some tax advantages. The parents also get to enjoy seeing the value in helping their children while they are still around, investing in them and their future, while also being present to help guide them in the homeownership process. This helps the children build equity that can later be used either to move on to another area or in purchasing a home upgrade.
I have recently noticed more parents taking an active role in assisting their children in buying a home, based on the financial and educational benefits, rather than having them wait for many years to receive as large an inheritance. There are several forms this assistance can take, including gifting of a down payment, outright purchase of the home, offering a family loan, or doing a shared purchase in one way or another.
Gifting a down payment – Lenders will generally allow borrowers to use money gifted from a family member as a portion of the purchase. However, if it is a recent gift, the borrowers must show the origin of the funds and a letter from the source affirming that it is a gift and does not need to be repaid. In some families it is set forth as an advance on their inheritance. The National Association of Realtors reported in 2014 that 32 percent of first-time buyers received a gift of money or loan from a family member for the purchase.
Providing a family loan – In some cases a family member may offer to loan money for the purchase, so the young buyers won’t need to go through a loan underwriting process. In today’s low-interest rate climate this can also be of benefit to the relative able to provide the funds, since they can have a higher income from the loan than they might get from bank deposits or CD’s. The borrowers would still be able to deduct the loan interest payments, same as they would have with a traditional loan.
Co-signing the loan – This option can be useful if the adult child’s income is not high enough to qualify for the loan on the home they want, even if they may have enough of a down payment. However, in such an arrangement, the parent becomes a non-occupant co-borrower, with potential disadvantages for the parents such as being obligated to make payments on the loan or property taxes if the children do not keep the payments up. The loan will also show up on their credit report as an outstanding obligation, which might complicate future refinancing or borrowing for another purchase.
Shared Equity – This is an arrangement whereby the parents own a portion of the property with the adult children, and it involves the children being responsible for making monthly payments (typically half of the principal, interest, taxes and insurance, as well as a portion of estimated fair market rental value). This form of purchase has great potential for parents who have high income and want to help their children with down payment and closing costs. It can also be useful for investors or friends to be involved.
I highly recommend consulting a financial advisor before committing to help the children buy with any of these options. I also suggest checking with your tax preparer to be aware of any potential tax implications of gifting or providing a loan, and perhaps even your attorney regarding any paperwork that might be advisable in case there is a divorce or default on the loan payment by the children. It may even be prudent to consider the prospect that any funds loaned might not ever come back, so parents would do well to be sure it are not risking their own future financial situation.
If a shared equity approach is being considered, the numbers need to be evaluated carefully and based on current tax laws. There are a great variety of shared equity arrangements possible, and the tax and financial planning factors are important considerations.
If parents or other family members are able and willing to help the first time buyers out, it will be very beneficial to have clear communications early in the process about what funds and under what circumstances they will be available. If there are siblings in the family, the parents may want to have discussions that will prevent jealousies and family feuds years later. The potential benefits to the whole family are great, though, as the property is a tangible asset that can add value for their future lives.
Michael Edlen has worked with more than 500 young families in their first home purchase, and is available for consultation without obligation. He may be reached at 310.230.7373, or Michael@MichaelEdlen.com.