Helping a loved one buy a home? Review strategies and risks
FAMILY & LIFESTYLE
Approaches range from offering a straightforward monetary gift to making the purchase yourself and becoming a landlord. Explore various strategies and their tradeoffs.
Real estate has long been one of the foundational pieces for an investment portfolio. But for younger generations, buying a home has become increasingly difficult. Younger homebuyers face all the same factors of a challenging purchase environment but may not have the ability to come up with a down payment or the earning power to qualify for a mortgage.
That’s where parents and grandparents can sometimes step in – with caution.
Before you open the door
Before you agree to aid a loved one to purchase a home, consider how your decision will affect your own long-term financial plan. Make sure that whatever support you offer won’t interrupt your own goals for the near or distant future, especially your path toward an ideal retirement. You may need to have difficult or emotional conversations prepurchase about why they need your help, what expectations both parties have, and how long-term costs like maintenance, repairs and utilities will be paid.
Choose a strategy
There are myriad ways you can help the next generation in homebuying, and each comes with its own set of parameters. Here are a few to consider, from gifting to lending. With established credit, you may be able to get a better lending rate than a first-time borrower. Your advisor can help you weigh your options.
Offer a monetary gift
- Straightforward vehicle
- Taxed as a gift if it exceeds the federal gift tax annual exclusion, up to $17,000 per individual or $34,000 per couple in 2023
- Need to provide a “gift letter” to lender specifying the amount and transfer date to verify the payment isn’t actually a loan
- You’ll incur tax consequences if you exceed your yearly gift minimum
Provide a loan or private mortgage
- Requires careful and detailed documentation
- Delicate negotiation of family dynamics and relationships
- Must formalize the loan with contract and schedule of monthly payments and interest as well as any penalties
- Adds to their debt burden just like any other debt
Loan backed by eligible securities
- Flexible and offers ready liquidity should a real estate opportunity crop up
- Securities held in a brokerage account serve as collateral against a loan or line of credit, usually at favorable rates
- You’ll take some risk and could lose your investments if there’s a default or market fluctuations
- You can still obtain a mortgage afterward if desired through a technical refinance
Become the landlord
- You purchase the home with a mortgage or cash and become the landlord, adding to your liabilities or liquidating assets to do so
- Can help build equity for your children or grandchildren
- Consider setting aside rent in a separate account to help tenants buy the home later. (Again, just be sure you’re not putting your own financial needs at risk by carrying a loan longer than you truly can.)
- Requires careful consideration of all potential long-term outcomes
Be a co-borrower
- You’ll be putting your own credit on the line and your credit could be impacted if payments are not made on a timely basis
- A last-resort option
- Could still require a high down payment
For many parents and grandparents, the price of rent for an apartment or house nearby campus is as expensive as a mortgage would be. For that reason, some choose to buy a house or apartment that their children or grandchildren can live in while they go to school. This could be especially advantageous if siblings will attend the same or nearby schools at the same time.
This arrangement can work many different ways. Some have their children or grandchildren pay them rent, which they apply to the mortgage, and then transfer ownership of the property at graduation. Some hold on to the property and continue to rent it to students after their children or grandchildren have graduated and incorporate the rental property into their total portfolio. Be sure to factor in normal, ongoing repair and maintenance costs and insurance as you do your feasibility calculations. There are also the costs and time associated with finding good tenants – including background checks and screenings. If you want to be more hands off or are a long distance from the home, a property manager can be a good way to go. But, keep in mind, they will take a percentage of profits, and you will still be on the hook for any direct repairs that need to be made.
It’s an approach that requires lots of consideration, clear arrangements with your family tenants and a long-term strategy before starting to shop the market. Talk through your strategy with your advisor and accountant to determine what financing vehicles are available and what potential tax advantages would accompany this approach.
Whatever route you choose, look at your long-term plans and goals, do research on the real estate market where you plan to buy, talk to potential lenders and discuss with trusted advisors to make a plan.