The bank of mom and dad

The No. 1 challenge for today’s would-be homebuyers isn’t their credit score, their income or how long they have been on their job. What’s holding back many young families from buying their first home is they just don’t have enough money for their down payment.

It must be frustrating for young families who should be buying right now but can’t. They look on as friends and cousins snatch up homes priced below what it would cost to build them with mortgage rates in the 3 percent range. They see fewer homes for sale and rising prices. They fear if they don’t buy a home soon, they will miss out on a historical window of opportunity in the California housing market. They have pretty good credit, a steady income and the desire to own their own home. They have some savings but not quite enough to for the 10 or 20 percent down payment and all the closings costs. So where can they turn for some help?

How about the bank of mom and dad? According to the National Association of Realtors, about a quarter of first-time homebuyers last year relied in part on gifts from relatives for their down payment and closing costs.

Assisting adult children with their first home purchase is a worthy endeavor for parents or other close relatives, who have the financial capacity to do so. Parents and grandparents understand how owing a home often strengthens family ties. Ownership solidifies a commitment to the community, builds character and offers long-term financial stability. But before mom and dad write the check, they need to evaluate the financial and tax consequences as well as any emotional backlash.

There are times when parents should not help their kids buy a home. Not every young family has the financial maturity for homeownership. Buying a home will not reverse an unstable marriage and helping one child with the down payment may be perceived as favoritism by another sibling. Family dynamics are often complicated and sensitive. Every family situation is different and must be carefully evaluated.

When the decision to offer financial assistance is positive, parents should sever any financial and emotional ties to the gifted money. Let it be a gift without any future expectations or emotional strings attached. Imposing performance conditions on the money can lead to resentment and hurt feelings.

Assuming parents are in a financial position to afford the gift for a portion of the down payment and the adult children are ready for homeownership, there are a few procedures that should be followed to comply with federal banking regulations and our friendly Internal Revenue Service.

Federal underwriting guidelines allow unlimited gift funds by close relatives toward the purchase of a home. The money cannot, however, come from close friends, cousins or a distant uncle. If the money is a loan and not a gift, lenders require proper documentation including a copy of the promissory note including the repayment terms. The borrowers would need sufficient income to qualify for the combination of the new mortgage and the loan from mom and dad. The source and path of the money, into escrow or the borrower’s bank account, must be fully documented. Lenders don’t want to see unexplained deposits showing up in banks account. The donors will also need to show where the money originated from.

The donor will need to provide the lender with a “gift letter” stating the amount of the gift, their relationship to the borrower, the money was indeed a gift and that repayment was not required. Check with your trusted mortgage professional or agent first to ensure proper compliance. When gifting money for a down payment, the proper format is as important as the gift itself.

The type of loan determines how heavily a borrower may rely on a gift from mom or dad. If the loan is a FHA, then borrowers can use any and all funds from parents to cover the down payment and closing costs. If it’s a conventional loan, lenders require the borrowers have at least 5 percent of their own funds in the deal. This minimum does not apply if the down payment is greater than 20 percent.

Before writing the check, would-be donors need to consider their liability under federal gift tax regulations. Individual gifts of $13,000 or less are exempt from the tax. Giving more than $13,000 to one person would eat into the lifetime gift-tax exclusion. That may seem low but wait, there’s more. If two parents wanted to help their married daughter into a home, each may give $13,000 to her and another $13,000 each to their son-in-law for a non-taxable total of $52,000. If a larger amount is required, the donors could spread the wealth and write one check in one year and another in the next for a total of $104,000. Be sure to check with your tax professional first.

Gifting the down payment is far better than co-signing for a loan. Co-signers have full financial liability for the mortgage and usually no control over occupancy or future disposition of the property. Volunteering to provide all or a portion of the down payment may be the incentive adult children need to strike out on their own path to independence.

Gifting is an advance inheritance, allowing the living donor the opportunity to observe the joy in their bequest. Helping children or grandchildren buy their first home may be one of the few opportunities remaining for parents and grandparents to ensure that their money is wisely invested.

Ken Calhoon is a real estate broker in El Dorado County. He can be reached through his Website at kencalhoon.com.