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.
Cosigning on a Mortgage
If your parents have limited income, the simplest way to help is by cosigning the mortgage.
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. (See also: Best Ways to Repair Your Credit Score.)
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.
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 $14,000 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.
If you’re giving money to both parents, that means you can give each one $14,000 without cutting into the lifetime exclusion (if you have a spouse, he or she can also gift up to $14,000 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. (See also: The Pros & Cons of Owning Rental Property.)
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.
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.
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.