Ben and Molly Setnick knew they wanted to buy a home.
And the payments and maintenance "really weren't an issue," Ben Setnick said.
Ben and Molly Setnick were able to buy a larger home than they had planned on after Molly Setnick's parents helped with the down payment. "We would have had to deplete all of our savings to put that much money down," Ben Setnick said. He considers the gift to be a valuable investment.
"We just didn't have the nest egg to make the down payment. We would have had to deplete all of our savings to put that much money down."
So it was a nice surprise when Molly Setnick's parents offered to help the young couple buy their first home.
"At first, we were uncertain about accepting such a large gift," said Ben Setnick, a 26-year-old systems consultant. "It's totally an investment for us because it enabled us to buy a larger house than we would have been able to buy on our own. It's the kind of house we can live in for 10 years instead of a starter house."
Parents often help
Parents pitching in to help their children buy a home is a long-standing tradition, housing experts said.
"Historically, parents have always been a source of funds for down payments, which in a sense explains some of the continuing disparities in homeownership," said Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University, which studies emerging housing and community development policies.
Parents who haven't been homeowners and therefore haven't accumulated the wealth associated with owning a home can't help their children buy a home, he said.
"Therefore, their children lose that potential resource," Retsinas said. "Many of the programs in the last decade have been trying to accommodate people who don't have access to people with resources."
Questions to consider
Financial advisers said parents should ask several important questions before deciding whether to help their children buy a home.
First, can you afford to help in the first place? You shouldn't jeopardize your own financial security to help your children.
"I've seen so many people give away money they have no business giving away," said Joan Gruber, a certified financial planner at Joan M. Gruber Advisors in Dallas.
The second question parents should ask is can their child afford mortgage payments? Parents need to remember that their children still must qualify for a home loan.
Gifts vs. loans
If you can afford to help your child and if the child can keep up mortgage payments, the next step is deciding how you want to provide the money: a gift or a loan?
Experts say a gift is the better route.
For one thing, it helps parents reduce the value of their estate, which saves on death taxes.
You may give up to $10,000 a year to as many people as you want without incurring any gift tax. If your spouse joins in making the gift, you may give $20,000 to each person annually without paying any tax.
Gifting is one strategy people use to lower the value of their estates.
That was the original intention of Molly Setnick's parents, only they had planned to gift some money further down the road, said her father, who didn't want to be identified.
But when the Setnicks found a house they liked, her parents decided it would be a good time to use their gift to help the couple make the down payment, Molly Setnick's father said.
"We didn't necessarily link it to a house until they began to say that they were going to buy a house," he said. "At this point, the down payment was an issue, so it just became an appropriate time."
The mortgage finance industry has programs that allow homebuyers to receive monetary gifts to help them purchase a house.
Fannie Mae and Freddie Mac, the two corporations that buy mortgages from lenders, offer such programs.
For example, Freddie Mac's Alt 97 program is designed for borrowers who have good credit but not enough money for a down payment.
Under Alt 97, borrowers may use a combination of sources to cover the down payment, including a gift or loan from a relative.
One of Fannie Mae's most popular mortgage products is Flexible 97, which allows borrowers to finance the required 3 percent down payment from a variety of sources, including a gift or loan from a family member.
Parents' monetary gifts must be clearly that: a gift with no strings attached. And all parties will have to attest to that.
"We're expecting that no repayment to the parent is expected," said Alice McManus, Fannie Mae senior underwriting consultant. "If they have to repay it, it adds another risk, and we have to consider that another debt."
What's more, a loan from parent could be considered a second lien against the home, she said.
"Some lenders don't like there to be second liens on the property," said Newsome, the real estate lawyer. "Many mortgages do not permit a second lien without the lender's consent."
Lenders want the borrower to have some of their own money invested in the house because they'll be less likely to walk on the mortgage, he said.
Lenders also don't like the possibility that the house as loan collateral could be foreclosed on by second lienholders, Newsome said.
There are other reasons why experts recommend against parents lending money for a home to their children.
"Loans between parent and children, especially if they're undocumented, tend to ultimately disappear, and the parent needs to understand that," Molly Setnick's father said.
And that can cause tremendous strain between parents and children.
Advisers also caution parents against co-signing a mortgage with their children.
For one thing, if your children can't pay the mortgage, you're on the hook.
"Avoid guaranteeing, avoid co-signing, avoid pledging your entire asset account above and beyond what is necessary," said Douglas Gill, a certified financial planner and president of Gill Capital Management in Dallas. "Avoid doing those things that open you to deferred liability."
That's what makes a gift a better tool, he said.
Finally, parents should avoid having their names on the title of the house with their children because it can cause all sorts of problems, advisers said.
The home "becomes subject to claims from the parents' creditors," Newsome said. "It would be subject to bankruptcy claims, should they file for bankruptcy, and it would be a part of their estate in the event they died, and all of a sudden, it has to go through the probate process."
No comments
Commenting is turned off for this story.