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Can Mom and Dad – or a friend or family member – help you get your first home, maybe with a loan, gift, or some credit? The answer in many cases is yes, but the process is hardly straightforward.
Buying a home is complicated and for many potential buyers the toughest problem is financing. That’s hardly a surprise because big money is involved.
The typical house now costs more than $400,000 so a 3% down payment by itself is a $12,000 cost. In addition, there are closing charges, moving expenses, and other cash that most buyers face.
Low-cost Down Payment Options
If you’re going to ask someone for financial help – or if they will reach out to you – you want to make every effort to hold down the amount you need. One of the best ways to reduce first-time barriers is to use financing that requires less down.
Good options include VA and USDA loans for qualified borrowers that require 0% down, FHA financing with 3.5% upfront, and the HomeReady (Fannie Mae) and Home Possible (Freddie Mac) programs with 3% down.
Smaller down payment requirements can significantly reduce upfront cash needs, but in some cases borrowers can reduce expenses even further with down payment assistance programs for first-time buyers. Such programs can include grants and interest-rate reductions.
There are thousands of such programs nationwide and the term “first-time” usually means that someone has not owned a house for at least three years. Also, often, there is an exception to the three-year rule in the case of divorce.
» MORE: See today’s refinance rates
The Bank of Mom & Dad (And Friends & Family)
Shakespeare long ago advised that in matters of finance one should “neither a borrower nor a lender be,” but sometimes parents, friends, and families want to help others. For those who have the funds and credit to do so, it’s a wonderful gesture, a kindness that can change lives.
According to NAR, “22% of first-time buyers used a gift or loan from friends or family for the down payment.” For those lucky enough to have access to such funding, there are several ways that friends and family can help.
Gifts. Under government rules, individuals are allowed to give as much as $17,000 in 2023 to another individual without setting off a tax consequence. The annual amount that can be made as a tax-free gift changes each year so check with a tax professional for details.
There’s no doubt that $17,000 in tax-free cash is a lot of money for many – the typical household earned $74,580 in 2022, according to the Census Bureau. You can bet that a lot of family gifts are far less than $17,000.
Alternatively, some households can take full advantage of the rules and in that situation, the help can be significant.
For instance, John is married to Rita. John’s father can give $17,000 to John and $17,000 to Rita. John’s mom can also give $17,000 to John and $17,000 to Rita. That’s a total of $68,000 tax-free in 2023 and the process can be repeated each year. In effect, gifts can be used to transfer significant wealth tax-free over time.
Lenders will want to know if some of your financing comes from recent gift money, generally funds provided up to three months before making a loan application. If that’s the case, lenders will likely want a gift letter from the donor confirming that the money is really a gift and that no repayment or interest is required.
Loans. If Mom and Dad have sufficient funds – or if they can borrow because of their good credit – they can loan money to others. A loan is different from a gift.
There’s no interest or repayment expected with a gift. There is an interest cost as well as a repayment requirement with a loan. IRS rules typically require at least a minimum interest rate and that interest is typically seen as taxable income for the lender, income that must be reported.
Lenders and loan recipients will want loan arrangements to be in writing so that everyone understands the transaction. For details and specifics work with an attorney or legal clinic.
Co-signers. It sometimes happens that a borrower has sufficient funds to acquire a property and make the monthly payments, but not enough credit to get financing or to get financing at a low rate. In this case, Mom and Dad or friends and family can offer to co-sign the loan.
Co-signing is not a minor commitment. The co-signers are responsible for repaying the debt, the entire debt, if the borrower fails to do so.
If the borrower does not make a payment or is late, the co-signers’ credit will be hurt. And even if all goes well with the loan, the co-signers may have less ability to borrow for themselves and others.
Should you speak with parents about buying a home with their help? Family dynamics vary widely, but if parents can help with down payment money or credit assistance then that can make the buying process a lot easier. And for about one in five buyers it’s a conversation that has paid off.