If you’ve reached the point where you’re financially stable, helping Mom and Dad obtain a new home may seem like a dream come true. But it’s also a decision that’s more complicated – and more risky – than you may realize.
There are a number of ways in which adult children can assist their parents with a new home purchase, from cosigning on a loan to offering funds for a down payment. Before proceeding, it’s important to realize the pros and cons of each approach.
- If your parents have limited income, the simplest way to help is by cosigning the mortgage.
- Help with down payment can be a powerful tool for seniors as a smaller loan is easier to pay down on a fixed income.
- Buying a home and renting it to your parents might be a good option because of the many tax deductions you qualify for.
Cosigning on a Mortgage
If your parents have limited income, the simplest way to help is by cosigning the mortgage. Cosigning means you sign your name to the mortgage documents, alongside your parents.
A cosigner could make it easier for parents with limited income to qualify.
The better your credit score, the lower the interest rate on a home loan may be.
Cosigning can simplify the transfer of assets for estate planning.
If parents have poor credit scores that could be an obstacle to obtaining a cosigned loan.
Cosigning could hurt your credit score if your parents default on the loan.
You're responsible for repaying the loan if your parents default.
Not that long ago, it was fairly uncommon for borrowers to need someone else’s name on their loan. But following the mortgage market crash, lenders have really tightened their underwriting policies. For individuals without a significant level of income, it became harder to qualify for a note or get favorable terms.
Bear in mind that most lenders will look at the credit scores of all borrowers before offering a loan. So if your parents have poor credit or went through a recent bankruptcy, a cosigner may not make much of a difference.
However, lenders typically combine the income of all the borrowers when determining the loan-to-value ratio. Therefore, a cosigner can make it easier to qualify for a bigger loan than a borrower might otherwise get.
Cosigning may also benefit you if your parents are reaching a more advanced age. The reason: When the child’s name is on the title and designated as a joint tenant with right of survivorship, the property will immediately transfer to them after the parents’ death. That can eliminate a lengthy and complex probate process.
But here’s the catch: Regardless of whether you live in the home or not, you’re equally responsible for the mortgage payments. If your parents fall behind a few years down the line, it will likely end up on your credit report.
In fact, cosigning can hurt your credit even if your folks consistently pay on time. Other lenders will see that you’ve taken out a large loan, even though you don’t live in the home. Should you want to find a bigger house yourself, the decision to cosign could make it more difficult to get approved for a mortgage.
The upshot is that while cosigning might seem like a relatively trivial move, it can have some very real consequences down the road.
Down Payment Assistance
Another way to help – and one that won’t put your credit in peril – is offering assistance with your parents’ down payment. This can be a powerful tool for seniors in particular because a smaller loan is easier to pay down on a fixed income.
You can help your parents buy a home without affecting your credit.
You don't have to cosign for a home loan or be responsible for the mortgage.
Lenders can accept down payment gifts when they're properly documented.
Depending on the home, you may need to part with a sizable amount of cash to cover the down payment.
Down payment gifts need to be properly documented for the mortgage lender.
Gifting down payment funds could trigger the gift tax.
But unless you have unusually deep pockets, it’s worth considering the long-term effects of this strategy, too. Any money you provide your parents now is money that you won’t be able to have during your own retirement, or for your kids’ college tuition.
If you do extend your parents money for a down payment, timing is key. Lenders tend to get skittish about a large deposit that has just made its way into Mom or Dad’s bank account. Why? Because it could represent borrowed money that they will have to pay back.
To avoid that problem, experts say it’s better to give the money far in advance. That way, when your parents do apply for the mortgage and the lender asks for the most recent bank statements, that deposit won’t show up.
Be aware that there may be long-term tax implications, depending on the size of the gift. The IRS allows individuals to give up to $15,000 a year to each recipient. Any amount beyond that goes against the donor’s lifetime gift-tax exclusion, which could result in a tax on larger estates.
Be aware that there may be long-term tax implications, depending on the size of the gift. The IRS allows individuals to give up to $15,000 a year to each recipient.
If you’re giving money to both parents, that means you can give each one $15,000 without cutting into the lifetime exclusion (a spouse can also gift up to $15,000 to each parent). For amounts larger than that, you may consider breaking the gift into separate installments to stay under the annual limit.
Renting to Parents
Yet another option is to buy the home and rent it out to your parents. This can be a tempting option because of the myriad tax deductions you may qualify for when you rent a property, including mortgage interest, property taxes, maintenance costs and depreciation expenses.
Buying a home as an investment property can yield tax benefits.
Renting the property out to your parents can create a secondary income stream for you.
Your parents won't have to go through the loan application and approval process.
Navigating the tax rules for investment properties can be tricky.
If your parents are unable to pay the rent, you'll have to be able to cover the mortgage.
Getting a loan for an investment property can be more complicated than getting one for a home you plan to live in.
But be careful: Lenders typically classify second homes as investment properties, which come with a higher interest rate than other mortgages. Those higher rates may offset any tax breaks you receive.
Lenders typically classify second homes as investment properties, which come with a higher interest rate than other mortgages.
Before you set the rent, know this: To take your landlord deductions, you need to charge a competitive price. If you’re asking less than the fair market value of the property, the IRS considers it a home for your personal use. Consequently, you can’t deduct rental-based expenses like depreciation.
You might be tempted to cut a deal for your parents, but make sure you understand the financial implications before doing so. Meeting with a tax advisor before you buy the rental property can be a good way to navigate those issues.
Top Ways to Help Mom and Dad Buy a Home
The best way to help your parents buy a home is ultimately the one that causes the least amount of financial stress for everyone involved. When deciding how to go about helping parents buy a home, here are some of the key things you may want to keep in mind:
- Credit scores. A good credit score is crucial for getting the best interest rates when borrowing. If you're thinking of cosigning or buying an investment property, consider what type of rates you're most likely to qualify for. Also, think about how cosigning could affect your credit if your parents are unable to meet their obligations on the loan.
- Cost. There are different costs that may need to be paid upfront or on an ongoing basis when helping parents buy a home. For example, if you're gifting money toward a down payment that's a one-time expense. But if you're investing in a rental property, you'll have to consider where mortgage payments, insurance, maintenance and repairs fit into your budget.
- Long-term planning. Helping mom and dad buy a home can provide some financial relief in the short term but consider what that may mean down the line. For example, if you cosign for a home or buy a rental property just for them what would happen to it if they were to move into a nursing home or pass away? If you hand over $50,000 for a down payment, would you be able to get that money back later if they choose to sell the property or pass it down to you? Having these kinds of discussions can help you decide if assisting parents with a home purchase makes sense for everyone involved.
You may also want to discuss the need for long-term care insurance if you believe your parents might require nursing care at some point.
The Bottom Line
For those who can afford it, helping Mom and Dad with a home purchase is one of the best ways you can support them in their later years. But before moving forward, it’s important to understand all the ramifications of your various options.