The old adage, “Never lend money to friends or family,” is why personal finance advisers recommend any help parents give their adult children in their homebuying efforts be in the form of a gift.
But be it a gift, or a loan, there are some things for both parents and their homebuying children to know.
Two-in-five first-time homebuyers this year have received some financial assistance for their down payment, according to a LendingTree survey, mostly from parents, including 80% of Gen-Z buyers.
For parents who can afford to help, deciding whether the assistance is a gift or a loan is a decision that is entirely a personal one that varies from family to family, based on trust, responsibility and ability to repay. Often, a gift is the better choice.
“Because in that case, I think, it can help avoid some bad situations that can arise if someone is not paying you back. That said, if you can negotiate fair terms for a loan that’s not going to break anyone’s back or lead to ill feelings, then, yes, there might be instances where a loan works out better,” said Jacob Channel, senior economist at personal finance resource site LendingTree.
What the IRS wants to know
Down-payment assistance from parents is not taxable income, but the IRS requires parents (or anyone gifting money) to report it if it exceeds $17,000 on an annual basis.
The gift is not automatically subject to a gift tax, but it will count against the parent’s lifetime gift-giving total, which could trigger a tax consequence for their estate upon their death. Even then, likely not, considering the current tax-free lifetime gifting exclusion is $12.92 million per person, according to NerdWallet.
Regardless, not reporting a gift that exceeds the current threshold could result in IRS fines and penalties.
The gift can actually be much more than that $17,000 before triggering tax reporting requirements.
“The $17,000 is per recipient and per donor. Therefore, a married couple with married parents could actually get $68,000 without triggering the IRS reporting rule,” said Raymond Quianzon, a certified public accountant and registered tax preparer in D.C.
What the lender will want to know
For the buyers receiving the gift, or a loan, for down-payment assistance, there are also reporting requirements. Not to the IRS, but to the lender.
If it’s a gift, the loan underwriter will require a gift letter, which states the exact amount of the gift, who is received from, and a signed statement confirming no repayment is required. This also explains to the lender why a large sum of money shows up in the borrower’s bank account, used to support an applicant’s reported monthly income and expenses.
If it’s a loan, the underwriter will require a document that states the amount, from whom the loan comes, and repayment terms. The loan will be counted along with the rest of the borrower’s debt payments, and could impact the size of mortgage approved, based on their monthly debt-service payments.
There is a gray area, and a common one, when the parent says, “Pay me back when you can.” That kind of handshake deal may seem best left at the family dinner table, but never lie on a mortgage application, either by intent or omission.
“The worst case scenario is dad gives the cash thinking it is a loan, and son takes the cash thinking it’s a gift. The bank forces them to sort it out by putting it in writing,” Quianzon said.
When parents should say no
For parents who are financially unable to help their children with a down payment, they should not consider taking on new debt themselves to do it.
“The worst possible place to get money for something like a down payment, would be something like a high-interest loan. If you somehow find a way to get a credit card company or something like that to give you access to money that you can give to your kid for a down payment, don’t. It would be an extraordinarily bad idea in most circumstances,” Channel said.
Retirement accounts should also be off limits.
The misconception about down payment barriers
With home prices at record highs, saving for the down payment is daunting, but perhaps not as daunting as many potential first-time buyers are expecting.
While 20% is the gold standard for a down payment on a mortgage, it is not common, especially among young, first-time buyers. Over the past three years, the average down payment for first-time buyers has been between 6% and 7%, according to the National Association of Realtors. Some loans require even less. An FHA loan requires as little as 3.5% down on the purchase of a home.
There are also many down payment assistance programs, both at the federal and local level, including programs available to buyers in D.C., Maryland and Virginia.
“HUD.gov is a great place to look to see what you may qualify for, even if the bank of mom and dad is happy to help. Homeownership may be closer within reach than previously thought,” said Jessica Lautz, deputy chief economist at the National Association of Realtors.
Of note, having the resources for a down payment, either from a gift or a loan, or through the borrower’s own savings, will have little impact on the loan approval process if the borrower’s credit is poor or income is too low for the loan they’ve applied for. Mortgage approvals are based on creditworthiness and ability to repay.
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