“Should I help my child buy a house?”
It’s surprisingly hard to buy a house. In today’s depressed housing market, home prices and interest rates are low. Normally that would mean that homes would be rapidly purchased, thus driving up home prices. But here in the “Great Recession,” buyers are finding it hard to qualify and often need to provide significant down payments.
More and more often, young people and couples are turning to parents for help in making that house purchase. From an estate planning perspective, the devil is in the details; the success of the transaction will lie in making the proper choices given the facts.
First, you need to decide whether the help is a gift or a loan. Second, you need to decide if there will be any type of security if it is a loan. Third, you need to decide how to treat the assistance in the parents’ estate plan (will or living trust).
If the assistance is a gift, then the advantage to the parent is that they move some money out of their estate, thus reducing potential estate taxes on estates over five million ($5,000,000). The disadvantage to the parent is that they might have to pay gift taxes on the transfer.
If the assistance is a loan, then there are two advantages that leap out. First, the parent can can secure the loan with a lien against the home. This would be a second, since the mortgage company is going to take the first position as the primary lender. Second, as a lender, the parent is creating a stream of income, essentially creating an annuity earning some interest.
The disadvantage of a loan is that if the parent suddenly needs money, the parent can’t pull the money out of the house, the way they could if they had put the money into a different investment vehicle like a mutual fund. Also, if the child doesn’t pay back or misses payments, they are unlikely to enforce the lien, thus making the lien a hollow threat. Finally, if the assistance the parent provides is to actually co-sign the loan, then they could be on the hook for the entire loan amount if child defaults, goes bankrupt, passes away, and can suffer credit blows from late payments.
Parents who want to help out should always remember that their investment could be lost due to child’s creditors foreclosing on the home with no other security. Therefore, it’s the assistance, rather than the investment, that should be the driving motivation.
Whatever choices the family makes, the parent’s act should be memorialized in a writing so it can be understood in the context of their estate planning. If this was a gift, was it an advance on their inheritance that should be taken into account when diving property among children? If it was a loan, will it be forgiven on parent’s passing or should it count against the inheritance? The idea here is to minimize the possibility of litigation between children on the parent’s passing by making the parent’s wishes about the assistance to that one child very clear.
If you’d like to help out your child with buying a house, or if you need assistance from your parent with a purchase, sit down with a certified financial planner and with an estate planning attorney to make sure it’s done right. You can call my office at any time for a free consultation at (858) 720-8250.
A great additional resource can be found here – a comprehensive review of parent/child mortgage help advice!