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If you’re close to your parents and you’ve done well in your career after leaving home, you can repay the love and sacrifices they made raising a family by buying them a home in their golden years.
Parents and children may want to live closer to each other, especially when grandchildren are involved, but some housing markets are out of reach for seniors. Unless parents have deep resources, moving from a cheap housing market in the South or Midwest to big city housing markets in places like California or New York on fixed incomes is virtually impossible.
Also, houses that were once perfect for raising a family may no longer be suitable as parents get older and want to live a simpler, downsized life.
Despite these challenges, children can help parents by buying them a home in several ways, including a couple of ways to create a smart long-term investment opportunity for a child. Here are some options to consider.
Buy a Second Home Outright
If you can afford the mortgage and other expenses, buying a second home and letting your parents live there as their primary residence is the best option. It makes the most sense if your parents are elderly with little savings or inconsistent income.
In addition to taking care of your parent’s housing needs, you can benefit from the rising value of the second home and increased equity over time. You may not even need to come up with cash for a large downpayment if you’ve been in your primary residence for some time.
It may be possible to tap into your current home’s equity to fund the purchase of the second home. If you have more than 20% equity in your home, you could do a cash-out refinance to turn your current home’s equity into cash to use for the second home. A cash-out refinance will likely give you a lower interest rate than another mortgage.
Of course, you need to protect your financial security, so reviewing your current finances is essential to ensure you can afford to pay both mortgages. You also need to plan that
the requirements to qualify for a mortgage are typically higher for houses where the owner will not live. That can include putting down at least 20% for a down payment. Credit scores and income requirements can also be much higher to offset the lender’s increased risk.
If you determine that a second home’s upfront and recurring expenses fit your budget, a conventional loan may be a great option. As part of this, you’ll need to decide how you want to characterize the mortgage loan for the second property.
Declaring it as a second home or an investment property will result in differences in your loan rate and taxes.
When paying taxes on a second home, you can still deduct the mortgage interest and property taxes on the second home and your primary home. However, if you already have a second home and have mortgages on it and your primary home, you can only claim the mortgage interest deduction on two of three properties if you buy a home for your parents.
If you take out a mortgage to buy a second home, you’ll have to list it with the bank as a second home or investment property if you don’t plan on occupying it as a primary residence. A loan for a second home (sometimes called a vacation home) has lender rules in a conforming mortgage that it must be at least 50 miles from your primary home.
You can get around this 50-mile requirement by tapping into a Family Opportunity Mortgage authorized by Fannie Mae and Freddie Mac. The program has no distance requirements from your primary residence to the property you are purchasing.
Take Out a Family Opportunity Mortgage
A Family Opportunity Mortgage capitalizes on a loophole in the Fannie Mae rulebook that states borrowers can take advantage of “owner-occupied” rates and guidelines if the person occupying the second home is elderly or has a disability and is unable to qualify for a loan on their own.
The loan has the same qualification terms as a mortgage on a primary residence, with a lower interest rate and down payment. It lets you buy your loved ones a home at the same down payment and mortgage rates as if you were going to live in the house.
Typically, when taking out a loan to buy a second home, most lenders ask for 10% to 20% of the home’s purchase price as a down payment. However, Family Opportunity Mortgage loans only ask for 5%.
Homeowner’s insurance premiums for a second home will also be more expensive and have higher interest rates, but this loan can help you avoid these costs.
Borrowers don’t have to include the home’s occupant in the loan, meaning an adult child or aging parent can qualify even if they have high debt or poor credit. This benefit is significantly helpful since senior citizens and those with disabilities often have high medical expenses that can negatively impact their credit.
Family Opportunity Mortgages also have high debt-to-income ratios. Conventional loans require you to have a debt-to-income ratio of around 40%.
That means your loan payment, other unsecured loans, and existing debts like credit card bills and car payments cannot be more than 40% of your monthly gross income. But Family Opportunity Mortgage loans consider that providing housing for elderly parents or an adult child with special needs is not easy for many households and will allow a debt-to-income ratio as high as 50%.
To qualify for a Family Opportunity Mortgage loan, you will need:
- A credit score of at least 620
- Steady employment for the last two years
- Sufficient and stable income to support all expenses of your current home as well as the one you are buying
- No recent foreclosure or bankruptcy filings
The home’s occupants must meet additional qualifications, including.
- They must have insufficient income or be unable to work to qualify for a loan.
- They can receive assistance income, but more is needed to enable them to afford a home.
- The home must be their primary residence.
As the borrower, you must provide proof of your relationship, proof of income, and a letter stating that you plan to retain your primary residence and that the purchase of the home is for the benefit of your elderly parents.
Family Opportunity Mortgage loans do not apply to all homes. It only covers single-unit dwellings and excludes timeshares, vacation homes, or any other type of investment home.
Also, the borrower must be the primary person responsible for controlling the house. A management firm cannot manage the home’s care or occupancy.
» MORE: See today’s refinance rates
Down Payment Assistance
If you’re not able to outright buy or finance a home for your parents, another option is to gift your parents a down payment which they can use to get approved for a loan in their names. This strategy makes them the owners instead of you and protects you from financial exposure.
Lenders tend to flag a large deposit that was recently made to a parent’s bank account because it could represent borrowed money that they will have to pay back. To avoid that problem, experts say giving the money far in advance is better.
There may be long-term tax implications, depending on the size of the gift. Lenders can accept down payment gifts, but they need to be properly documented for the mortgage lender.
Somewhat related to this, children can also assist as a non-occupant co-signer on a home loan for a primary home for their parents. As a co-borrower, the children would accept the responsibility of making mortgage payments, just as their parents would, and the children would cover any lapses in mortgage payments.
However, children are now responsible for that debt so this option needs to be weighed carefully.
Loan programs vary for co-borrowers. Some allow the parents and children’s incomes to be counted together to qualify for the loan, and others may require each to meet certain income standards.
For tax deductions as a co-borrower, either the child or parent can take the deductions on the parent’s home, or both can as long as the deductions are split and don’t add up to more than 100% of what is allowed.
Another important thing to note is that if you co-sign a home loan with your parents or give them some type of financial assistance to buy a home, it could jeopardize their eligibility for Medicaid. Because it is a needs-based assistance program, certain types of financial assistance could be considered a countable asset if the home is in the parents’ names.
Become Your Parents’ Landlord
If you have the means to buy a home for your parents but need help with ongoing monthly expenses, you can consider renting your home back to them.
You can enjoy the benefits of being an investment property owner but mitigate some of the financial risks by renting it back to them at a price that makes sense for both parties. However, renting to them at a below-market rate won’t allow you to claim all the tax deductions you normally would as a landlord because the home is considered for personal use only.
One way to get around this is to claim your parents as dependents, which you can do if they make a certain amount of income and you pay more than half the support costs.