Bad things sometimes happen to good people. Some real estate problems don’t have a solution. When that happens, it’s often best to accept the situation and move on than dwell on our misfortune. Most of the time, when I’m asked for advice on real estate or a financial matters, there are clear alternatives: Buy, sell, hold, rent, refinance, run; crunch the numbers, assess the risks and, presto, here is the solution. But occasionally I come across a real estate situation that has no solution. It’s another tragic story with no satisfactory ending.
A few years back Ted and Martha wanted to help their daughter and her husband buy a home. After all, Martha explained, homes were steadily appreciating and owning a home would stabilize their daughter and son-in-law’s uneasy marriage. The kids were OK with owning a home but previous credit issues with the son-in-law and his inconsistent income prevented them from qualifying for a loan. That’s when Ted and Martha volunteered to provide the down payment and co-sign the loan papers.
Fast forward a few years. The kids are divorced, the house is in foreclosure and not only has Ted and Martha’s $50,000 downpayment disappeared but their credit is ruined with the foreclosure action against them. My meager advice was to discuss with an attorney the potential for a legal claim against their agent or loan originator for failing to advise the parents of the potential liability in co-signing loan papers and to contact their tax professional about possibly deducting the $50,000 as a capital loss. I was afraid both claims were weak. They were pretty much stuck in a bad situation.
Occasionally agents will get too creative in putting together a real estate deal. Bringing in mom and dad’s money for a down payment is an acceptable practice, providing everyone is aware of the potential consequences. Having mom and dad as co-signers is legally permitted but should only be considered as a last resort with a firm warning against it. There are better alternatives to help the kids buy a home, or perhaps they shouldn’t.
The down payment continues to be the largest obstacle for many otherwise well-qualified buyers. In a recent survey by real estate information company Trulia, 62 percent of surveyed adults younger than 34 said coming up with the money for the down payment was the primary reason preventing them from buying a home. Only 36 percent identified qualifying for a mortgage as the stumbling block.
Back in the day down payments were not an issue. Lenders offered a wide variety of low and no down payment programs. Highly leveraged purchases were a sign of a sophisticated smart purchase. That’s all changed. Today lenders want a substantial chunk of the borrower’s cash invested in their collateralized home. Conventional financing typically requires a 20-percent down payment in order to qualify for the lowest interest rates without mortgage insurance.
FHA loans have a low down payment requirement of 3.5 percent but, up until 2006, the maximum loan amount that FHA would finance was too low for most county buyers. Although the interest rates are competitive with conventional loans FHA mortgage insurance is very expensive.
Sellers are prohibited from assisting buyers with a down payment but they can, under normal circumstances, pay all the buyers closings costs — 3 to 5 percent of the loan amount. This enables the buyer to direct all their available cash toward the down payment.
Mom and dad remain big contributors for down payments. According to the California Association of Mortgage Brokers, about 35 percent of all first-time buyers receive a cash gift from parents or family members to be used toward a down payment. Under federal tax law, each individual is permitted to give away up to $13,000 to a single recipient in a calendar year. A married couple could bestow up to $26,000 a year. That could amount to $52,000 between this week and after New Year’s.
Rather than gifting, parents can loan their children the down payment. The loan would need to have proper documentation, scheduled repayments and the buyer’s income would need to be sufficient to support both the bank’s loan and the loan from the parents. The minimum interest rate that the IRS requires to family members is at an all time low of 0.2 percent for loans less than three years and 1.27 percent for loans of less than nine years but greater than three and 2.8 percent for all loans longer than nine years.
Another alternative is for parents to buy the house themselves outright and then flip it to the kids and act as the lender. This could benefit the parents if they have access to investments dollars stuck in a low interest bearing saving account. If at some future point the parents decided to forgive the mortgage, it would be considered a gift.
Before mom and dad provide any financial support to their children they need to assess their own financial situation. If they have financial resources and are willing to help with a home purchase, they should next assess the risk of defaulting children and their response if that happens. Gifting may be preferred than the stress of a debtor/creditor relationship. Parents should seek professional advice when structuring down-payment assistance that may be considered an advance of their children’s inheritance. Gifting and lending money for a home purchase have become more complex than just writing the check.