Rising rents and student loan debt make it difficult for many young adults to save for a down payment, so families often lend a helping hand. According to a 2022 report from the National Association of Realtors, 25% of home buyers ages 23 to 31 received a gift of money for a down payment and 4% received a loan.
But whether that help is a gift or a loan, make sure your parental generosity doesn’t backfire. The IRS has strict requirements for what qualifies as a gift or a loan. You also shouldn’t be helping your kids buy a home that is too expensive. “Parents shouldn’t subsidize their kids’ lifestyles, but just help them with part of the down payment on a home they can afford,” says Christopher Jones, a financial planner in Hermosa Beach, Calif.
Mortgage lenders generally allow a relative to provide the entire down payment and even closing costs. In 2022, you can give up to $16,000 to anyone without filing a federal gift tax return or nibbling away at the current lifetime estate and gift tax exemption of $12.06 million. Your spouse can also give up to $16,000, and you both could give another $32,000 if the recipient is married.
Lenders must verify that your gift isn’t a loan in disguise, which would add to your child’s debt load and could even disqualify him for a mortgage. You must provide a signed “gift letter” that specifies the amount and transfer date of the money and states that you don’t expect repayment. The lender will need to confirm that you have the funds and other documentation. Money provided at settlement should be a certified or cashier’s check.
To qualify for a mortgage, borrowers must make a down payment from their own funds, including gift money. After that, your loan can be any amount, and if it reduces a first mortgage to 80% loan-to-value, your child won’t need to get private mortgage insurance. Your loan must be subordinate to the first.
When you lend money to a relative, the IRS wants assurance that the loan isn’t a gift in disguise. As a result, the agency sets a minimum interest rate—the applicable federal rate—that you must charge. In June, that rate was 2.21% for loans of up to three years; 2.93% for a period of more than three and up to nine years; and 3.11% for more than nine years. The mortgage lender could require you to charge more. The interest must be reported as income on your federal tax return, and if you don’t charge at least the minimum rate or collect the interest, the IRS could force you to pay income taxes on the interest it believes you should have received.
To establish the legal debt between you and the borrower, you’ll need a promissory note. To secure the loan with the property as collateral, you must obtain a deed of trust to be registered with the county where the property is; doing so enables your borrowers to deduct the interest they pay. A real estate lawyer can draw up these documents for you.
National Family Mortgage (www.nationalfamilymortgage.com) also can set up and document the loan, and coordinate with the settlement agent. The cost rises with the loan’s size. For a loan of $100,000 or less, the cost is $725. If you don’t want to act as the loan servicer, NFM will do it for you for a $55 set-up fee and a small monthly servicing fee.
Coming up with the money
Even if you can afford to make that gift or loan, you may not have the cash readily available. To avoid selling assets, paying taxes on any capital gains and losing the income or appreciation those assets might have generated, you could fund the loan or gift from a non-purpose line of credit using a taxable investment account as collateral, says Eric Walters, a financial planner in Greenwood Village, Colo. To be clear, this isn’t a margin account, and you can’t use the line of credit to buy additional investments.
The interest rate is based on the one-month Secured Overnight Financing Rate, plus the bank’s spread. For example, in early June, TD Ameritrade charged a rate of about 5% for a line of credit of $100,000 to $250,000 and 3.3% on $500,000 to $1 million. You pay interest only on the portion of the credit line you use.
The key is to take the largest line available to you and use only a small portion, says Walters. You must repay at least interest on that portion each month. If the value of your portfolio falls below the lender’s threshold—say, 70% for a portfolio of stocks and bonds—you will need to deposit additional funds or securities
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