Your parents have decided that it is time to move and want to buy a house. Maybe they want to live closer to their grandkids, their current house no longer meets their needs, or they want to retire in a peaceful neighbourhood. Unfortunately, the ever-increasing prices of real estate may thwart their plans as they discover they cannot afford a new home on their fixed income.
If you have always wanted to show gratitude to your parents and you have finally reached a stage in your life when you are financially stable, helping them to buy a house might be a perfect opportunity to do it. And you can do much more than simply researching gorgeous locations, advising and accompanying them to the showings. In this case, you could offer down payment assistance, co-sign on their mortgage, become their landlord, or simply buy the house for them.
However, real estate is a major investment, and your decision will have an impact on your bank balance, so you have to weigh your options carefully. Here is what you need to know:
Co-signing on a Mortgage
One way to help your parents buy a house is to co-sign on their mortgage. It is an especially attractive solution if your parents have a low income and might have a problem qualifying for the loan, or they may not score the best terms. For example, a lender could require a larger down payment than they can afford, or the interest rate may be higher than planned. In this case, a co-signer might improve the situation.
Still, you need to remember that the loan programs vary for co-borrowers. Some will allow counting the parents’ and children’s incomes together when determining the loan-to-value ratio, which will help qualify for a larger loan. Other lenders might require both parties to match a certain income standard. If your parents have a poor credit score, a co-signer may sadly have no significance in the whole matter.
Co-signing might also be a great way of figuring out the issue of inheritance. If you become a co-owner of your parents’ new house with the right of survivorship, then after their death, the property will be immediately transferred to you. This solution will eliminate the probate process that is often very lengthy and complex.
However, you should bear in mind that co-signing on a mortgage means accepting the responsibility that comes with the loan. You are equally on the hook for that debt. If your parents fail to pay the instalments, it will also affect your credit report. Additionally, you can have a problem taking another loan for yourself since there is already an existing debt on your bank balance.
Down Payment Assistance
An alternative solution is to give your parents some financial relief to help them with the down payment. In this case, your parents will be the sole owners of the house, and your credit score will not be affected in any way. Moreover, your parents will have an easier time paying off the debt since a larger down payment usually means smaller monthly payments.
Your down payment gift for your parents must be properly documented to ensure that everything is according to the law. This may carry long-term tax implications depending on the amount of money you gift. As of now, the rates of gift tax range from 18% to 40%, and the giver generally pays the tax. However, you may be exempt from paying if you do not go beyond a limit. In 2022, you might give up to $16,000 to someone in a tax year and not have to file a gift tax return. Note that the limit is for each recipient. That means you can give each parent $16,000.
Furthermore, you have to give your parents money far in advance. A large deposit in your parents’ bank account might flag the suspicion of the lenders. They might think it represents borrowed money that your parents have to pay back, which will affect their ability to pay off the mortgage. But if you gift the money earlier, the deposit will not show when the lenders ask for the most recent bank statements.
Becoming Your Parents’ Landlord
If your parents cannot qualify for a mortgage on their own or would rather not go through the loan application and approval process, you could buy the house yourself and rent it to them. This is quite a tempting option since it brings the benefits of being an investment property owner, including tax deductions such as mortgage interest, property taxes, maintenance costs, and depreciation expenses.
You will probably want to offer your parents rent at a price they can afford. However, if you charge them less than the property’s fair market value (FMV), the home is considered for personal use only. As such, you will not be able to claim all of the tax deductions. You can go around this rule by claiming your parents as dependants, but their gross income cannot exceed a certain amount ($4,300 for the tax year 2021), and you have to provide more than half their support costs.
In Conclusion
Helping your parents buy a house is an excellent way of demonstrating your love and respect. But it also means that you have to weigh the financial impact of your decision. Additionally, you need to consider your parents’ preferences. Some will be anxious to buy a new home as soon as possible, while others may choose not to deal with the hassle. Make sure you know what they want before making any significant moves.
If you are not sure how to proceed, you can always contact a financial advisor to help you find the best solution.