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Should parents give or loan money to help adult children buy a first home? It’s a difficult question because more than cash is involved.
Both parents and children must consider such issues as rates, terms, written agreements, family finances, and personal dynamics. That said, let’s look at the central questions families must consider.
First, if a borrower puts 20% down, monthly payments will be significantly lower and the lender will not require mortgage insurance, a big savings. However, 20% down is impractical for most households.
That’s because the typical existing home sold for $382,600 in December 2023, according to the National Association of Realtors (NAR).
Twenty percent down for the typical home amounts to $76,520. Few families can afford to pay so much upfront.
If there is more than one child to consider, the down payment problem can be even more difficult. NAR reports that in 2023 first-time buyers put down an average of 8%.
NAR also says that family help is important for many first-time buyers, and that “23% of first-time buyers used a gift or loan from friends or family for the down payment.”
Second, in addition to looking for loan programs with little down, families should also see if down payment assistance programs (DPAs) are available. DPA programs may offer such options as grants, interest-rate reductions, and “soft” loans that may not have to be repaid.
Less cash is needed from friends and family if first-time buyers can get DPA help.
Third, according to the IRS, there’s an $18,000 annual gift exclusion in 2024. This means, for example, that a child can receive as much as $18,000 from a mother and $18,000 from a father, a total of $36,000 tax-free.
The parents can also give as much as $18,000 each to a spouse, or another $36,000 tax-free. In effect, families with sufficient financing can give a combined $72,000 tax-free to their children this year. Next year, if the parents choose, they can repeat the process with the 2025 annual exclusion.
Fourth, it’s important to carefully document gifts because of annual limitations and possible estate issues.
Most households will not have to worry about estate taxes because there’s a massive basic exclusion amount (BEA). According to the IRS, “The tax reform law doubled the BEA for tax-years 2018 through 2025. Because the BEA is adjusted annually for inflation, the 2018 BEA is $11.18 million, the 2019 BEA is $11.4 million and for 2020, the BEA is $11.58 million. Under the tax reform law, the increase is only temporary. Thus, in 2026, the BEA is due to revert to its pre-2018 level of $5 million, as adjusted for inflation.”
How many households actually pay estate taxes? Not many. In 2020 about 2.8 million people died and of that number roughly 1,900 paid a federal estate tax, according to the Tax Policy Center.
Many households do not have the financial ability to write a large down payment check. However, there still may be a way to help adult children get that first house even with few parental dollars.
According to the Census Bureau, 19.7% of men and 12.3% of women aged 26 to 34 live at home in 2023. Adult children may be able to save a substantial amount of money if they can live at home rent-free.
For example, if a local entry-level apartment rents for $1,500, then a working adult child who lives at home can effectively save that much each month. At the end of the year there will be $18,000 in savings.
To finance a $400,000 home with an FHA mortgage requires 3.5% down or $14,000. No doubt more down will be required for closing costs and such, but $18,000 is surely a good start and — as we saw – one person can give a tax-free gift to an adult child of up to $18,000 in 2024.
The concern with adult children living at home may involve family dynamics and social standing. But – realistically – avoiding rent for a brief time to save a down payment can be a life-changing financial option that helps adult children with an interest in homeownership.
Down Payment Gifts
Parents may be able to help with a gift to pay some or all of the down payment. A “gift” is a form of assistance where no principal or interest will be paid. Lenders will require a letter showing that the money is a gift and not a loan.
The size of a down payment can vary, depending on how the property is financed. FHA loans typically require 3.5% down, the HomeReady (Fannie Mae) and Home Possible (Freddie Mac) programs are at 3%, while VA and USDA loans are available to qualified borrowers with 0% down.
Money not used for the down payment can be used to offset closing costs.
» MORE: See today’s refinance rates
Mom and Dad Mortgages
If a family has sufficient assets, and if family dynamics allow it, it may be possible for adult children to get a loan from the Bank of Mom and Dad. The borrower may be able to get the best available rates while the parents get a steady income stream.
With a parental mortgage the usual underwriting standards need not apply since this is a private loan. However, for tax and estate reasons, and so that everyone understands the financing terms, a written mortgage agreement is required.
Although many families cannot provide down payment cash to home-buying children, they may well have another asset that can help: A willingness to cosign a mortgage.
This sounds easy at first. All the parents have to do is sign a few bits of paperwork and the deal is done.
No checks required, no need to raid financial accounts. However, cosigning can represent significant risk. By becoming a cosigner, the parents, along with the adult child or children co-borrowers, are each responsible for the entire loan.
The parent’s credit can be hurt if payments are missed or late. There can be additional interest and charges. The parents’ ability to get new financing for a home or car may be limited by cosigning a loan.
We usually think of real estate as being either owner-occupied or owned by investors. If you’re an owner-occupant and itemize deductions, you may be able to get your share of tax deductions for property taxes and mortgage interest.
As an investor, you may be able to deduct your share of taxes and interest as well as proportionate deductions for depreciation, repairs, utilities, HOA dues, insurance, and management costs.
It is possible to have a property owned by both an owner-occupant and a non-occupant investor. This is called shared equity, a form of ownership that first became available in 1981 under the Black Lung Benefits Revenue Act, an example of how things get done in Washington.
The way it works is that an investor and an owner-occupant put up the money needed to acquire the property. They then pay bills according to their ownership percentage.
The owner-occupant pays rent for the use of the investor’s interest in the property. The investor, in turn, must pay a part of the mortgage, taxes, etc. The loss or profit from a sale will be divided according to the shared equity agreement.
The Gift of Knowledge
Financing for first-time homebuyers often requires that borrowers take a brief real estate education class. There’s a lot of sense to such classes, but parents may want to go further: Before buying anything, Mom and Dad can offer to pay for real estate license classes.
Such classes are a good way to learn about the real estate market and mortgage financing, plus – if graduates are interested – they may qualify to take the state real estate license exam and enter the field. Speak with local real estate brokers for class suggestions, and be aware that larger firms may have their own classes.
Such financial steps as loaning money, providing a gift, cosigning a mortgage, or investing with adult children are all business transactions and must be treated like one. This means documents must be prepared by an attorney and that parents and children must have wills and related paperwork.
Also, such assistance may have substantial tax consequences, so it makes sense to speak with a tax professional.
Why such formalities? Because we don’t know what will happen in the future.
Relationships can change, there could be a divorce, a lawsuit might arise, etc. A written agreement can also provide clear guidance in the event of a dispute among family members.
And yes, it’s true, attorneys want to be paid. However, it’s a lot cheaper to get legal work done upfront than to finance lengthy court battles and tax disputes.