If you’ve reached the point where you’re financially stable, helping your parents get a new home may seem like a dream come true. But it’s also a decision that’s more complicated and riskier 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.
- There are many ways you can help your parents if you want to help them buy a home.
- The simplest way is to cosign the mortgage, especially if they have low incomes.
- Help with a 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.
- Be sure you consider the short- and long-term implications before you agree to help.
Cosigning on a Mortgage
The simplest way you can help your parents is by cosigning the mortgage, or signing your name alongside your parents' on the mortgage documents, especially if they have low income. This wasn't always the case, though, as it used to be uncommon for borrowers to need a cosigner. But when the housing market crashed, lenders tightened their underwriting policies, making it harder for lower-income individuals to qualify or get favorable terms.
Bear in mind that most lenders review the credit scores of all borrowers before offering a loan. As such, a cosigner won't make much of a difference if your parents have poor credit or recently filed bankruptcy. But lenders typically combine the income of all the borrowers when determining the loan-to-value ratio so having a cosigner can make it easier to qualify for a larger loan.
Cosigning may help if your parents are older. That's because when the child’s name is on the title and designated as a joint tenant with the right of survivorship, this means the property can be immediately transferred after death, which eliminates a lengthy and complex probate process.
But 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. Having a large loan—even if it's paid on time—can also bring down your score and make it harder for you to get any credit for yourself.
Parents with limited income may easily qualify.
A better credit score means a lower interest rate on the mortgage.
Assets for estate planning can be easily transferred.
Parents with poor credit scores may prevent getting a cosigned loan.
Cosigning could hurt your credit score if your parents default.
You're responsible for repaying the loan if your parents default.
Down Payment Assistance
Consider helping with the down payment if you don't want to hurt your credit score. This can be a powerful tool for seniors because a smaller loan is easier to pay down on a fixed income.
Lenders tend to get skittish about a large deposit that was just made to a parent'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. If a lender asks for their most recent bank statements when they apply for the mortgage, the deposit won't show up
There may be long-term tax implications, depending on the size of the gift. The Internal Revenue Service (IRS) allows individuals to give up to $15,000 for the 2021 tax year ($16,000 for 2022) to each recipient. This means you can give each parent $15,000 in 2021 (or $16,000 in 2022) without cutting into the lifetime exclusion (a spouse can also gift up to the $15,000 or $16,000 limit to each parent). Consider breaking the gift into separate installments to stay under the annual limit for larger amounts. Larger amounts count against your lifetime gift-tax exclusion, which could result in larger estate taxes.
You should also be sure to consider the long-term effects of this strategy unless you have deep pockets. Any money you provide your parents now is money you won’t have later.
You can help your parents buy a home without affecting your credit.
You don't have to cosign or be responsible for the mortgage.
Lenders can accept down payment gifts that are properly documented.
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.
Giving them the down payment could trigger the gift tax.
Renting to Parents
Why not 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:
Lenders typically classify second homes as investment properties, which means you'll probably have to pay a higher interest rate than the mortgage on a primary residence. Those higher rates may offset any tax breaks you receive.
In order to take your landlord deductions, you need to charge a competitive price. If you’re asking for less than the fair market value (FMV) of the property, the IRS considers the home for your personal use. Consequently, you can’t deduct rental-based expenses like depreciation.
You may 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.
Buying a home as an investment property can yield tax benefits.
Renting the property to your parents gives you a secondary income stream.
Your parents won't have to go through the loan application and approval process.
Navigating the tax rules for investment properties can be tricky.
You'll have cover the mortgage on your own if your parents can't make the rent.
Loans for investment properties can be more complicated than getting those for personal use.
Top Ways to Help Your Parents 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. Here are some of the key things you may want to keep in mind when deciding how to help your parents buy a home:
- Credit scores. A good credit score is crucial to secure the best interest rates. Consider the rates you'll qualify for if you plan to cosign for your parents or if you intend to buy an investment property. Make sure you consider how cosigning could affect your credit if your parents can't meet their financial obligations.
- Cost. There are different costs that may need to be paid upfront or on an ongoing basis. For example, gifting money toward a down payment is considered a one-time expense. But if you invest in a rental property, you'll have to consider where mortgage payments, insurance, maintenance, and repairs fit into your budget.
- Long-term planning. Helping your parents buy a home can provide some financial relief in the short term, but consider what that may mean down the line. For example, what would happen to the home if you cosign and they 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 if they choose to sell the property or pass it down to you? Having these 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 parents 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.