The housing market is a tough nut to crack these days. Prices are hitting the stratosphere thanks to low inventory, which is sparking bidding wars among buyers. Landing a home can seem impossible for younger buyers, who may need help with the down payment or qualifying for a mortgage. One-third of millennials report that coming up with the money for a down payment is the biggest obstacle to buying a home, according to the American Bankers Association. In fact, it takes 10 years, on average, for most home buyers to save a 5% down payment.
However, buying a first home is a lot easier if the bank of mom, dad, grandparents, extended relatives and friends can be tapped. In a recent survey of home buyers by ServiceLink, a mortgage lending company, 28% of respondents reported they inherited money or received money as a gift from their family and friends to help purchase their home. If parents or grandparents have deep pockets, they could even finance the entire purchase—usually with the stipulation of being repaid.
If you want to help your kids or grandkids get their first home, here’s what you need to know about gifting or lending money or co-signing a mortgage.
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Give a gift. If you want to keep things simple, gifting cash or stocks is probably your best option. If you’re worried about future estate taxes, it can help you reduce the bill. But pay attention to the gift tax laws.
The federal estate tax exclusion amount is $11.7 million for 2021 ($23.4 million for married couples). You can give up to $15,000 per person to as many people as you’d like during the year without having to file a gift tax return. If you’re married, your spouse can also give $15,000 per person, increasing the annual tax-free gift to $30,000 per person. That money offsets the value of your estate when you pass away.
After the money is gifted, the mortgage company will require a “mortgage gift letter” from your child and your child’s spouse (or partner). The letter will detail the relationship between the gift giver and recipient, the amount gifted, and where those funds came from. (If the money is a loan that’s expected to be paid back, the child must let the mortgage lender know because it is factored into the debt-to-income ratio.) The lender may require other documentation, too, such as bank statements.
You can also gift stocks. Ideally, you’ll want to give stocks you’ve owned for more than a year so that your child will qualify for long-term capital gains rates when he or she sells the stocks to help finance the home purchase.
When you give stocks (or other investments) to a child, your child’s basis when he or she sells the stock will be your original basis (your holding period will also transfer with the stocks). For example, if the stock was worth $10 a share when you bought it and your child sells it for $50 a share, your child will owe capital gains taxes on $40 a share. But if your child is in a lower tax bracket, he or she may owe a lower tax bill than you would have paid—or avoid it entirely. In 2021, individuals with a taxable income of less than $40,401 (or $80,801 for couples) pay no capital gains tax on stocks. Above that, the rate is 15%, and it rises to 20% for individuals who have taxable income of more than $445,850 ($501,600 for couples).
Be the lender? Another option is to become what’s known as a non-occupant co-borrower. In this case, you and your child apply for the mortgage together, and both of you are responsible for the payments. This is a beefier situation than being a co-signer. As a co-signer (discussed below), you are guaranteeing that you will pick up the payments if the primary owner can’t. As a co-borrower, you are responsible for making payments, and you can also add your own money to the down payment pot. Plus, you usually earn equity, just like the other borrowers, even though you don’t live there. If the property is sold, you may be entitled to any profit made, depending on the loan type and the agreement you have with the co-borrower.
You may also be able to deduct your portion of the mortgage interest paid as a non-occupant co-borrower if you itemize deductions on your tax return. However, with the standard deduction nearly doubling thanks to the 2017 tax overhaul, many homeowners no longer realize a lower tax bill by itemizing.
To approve the arrangement, the lender may require a family connection—typically that you are the parent or stepparent or grandparent. A longtime family or personal friend may not qualify.
If you don’t have a chunk of money to give away—or you would prefer not to—co-signing the mortgage may significantly boost your child’s chances of approval. You then become legally obligated to repay the loan in the event your child can’t.
“If you feel you’re going to regret the decision, don’t do it. You don’t need to erode the relationship you have with your child or whomever you’re co-signing for,” says Douglas Boneparth, a certified financial planner in New York City.
If you co-sign, the lender will take into account your income and other assets when evaluating the loan application. As with being a co-borrower, the lender may require family ties between the two parties.
The silver lining to both situations is that they don’t have to be permanent. If the financial profile of your child and his or her spouse improves, they may be able to refinance the loan on their own. Note that if you’re a non-occupant co-borrower, things may get tricky in a refinance. You may or may not decide to negotiate a buyout for your stake in the property—similar to when couples end up divorcing—and the share of profits you get may depend on any agreements you made beforehand.
Whether you give cash or stock, lend money, or co-sign the loan, all parties involved need to have realistic expectations. For instance, certified financial planner Felicia Gopaul says her father stipulated that his cash gift be used to buy a home that she could afford and not necessarily the home she wanted, pointing out that she and her husband could always upgrade to a bigger home later.
Boneparth agrees with the sentiment. “If the reason they don’t qualify for a mortgage is pandemic-oriented—the market is just frothy and ridiculous—but you know they’re a good borrower, that’s one thing,” he says. “But if they can’t afford it in normal times, they can’t afford it.”