Parents may be able to help their children buy a home, but it pays to weigh all options first
A home for sale sits behind a sign that reads, "sale pending," Wednesday, Aug. 14, 2013, in San Diego. (AP / Gregory Bull)
Rising prices and a dearth of homes for sale in many markets have made it harder for many looking to buy their first home.
One of the biggest obstacles many are facing is saving up for a down payment, particularly in hotter markets where competition for the more affordable homes can quickly drive up prices and put pressure on buyers to bring more cash up front.
That trend is prompting many parents to step in, some opening their wallets, others welcoming their adult children to live with them again temporarily while they save money or pay down debt.
Some 13 per cent of parents with children between the ages of 20 to 38 helped their child buy a home in the last five years, according to a survey conducted by GfK Custom Research North America for lender loanDepot.
Of those, 65 per cent contributed the down payment and 24 per cent assisted with closing costs. The survey, which was conducted in February, included responses from 1,000 parents and has a margin of error of 3 per cent.
Whether it's a cash gift or another form of aid, it pays for parents to consider how to best aid their children without placing their own financial well-being at risk.
Here are some factors parents should weigh when helping their children buy a home:
Assess your finances
Parents may be tempted to pitch in financially to help get their children into their first home, but they shouldn't do so before going over their own finances and ensuring they can they can afford to live without the funds.
This is particularly important if the parents are close to retirement, when they will have to live on their assets, savings and investments.
"Do not in any case put your retirement security at risk just to get your child into a home," said Elizabeth Grahsl, a private banker at Prosperity Bank in Dallas. "He or she will have plenty of chances to own real estate, but you probably don't have time to catch up if your retirement is derailed."
An accountant or financial adviser can help figure out whether you can afford to make a sizeable contribution to your children's homeownership fund.
Another option is to use an online retirement calculator to estimate the impact that any big withdrawals would have on your retirement savings.
Go with cash
If you decide to kick in some money toward your child's down payment or other costs, it's best to go with discretionary cash, say from a savings account. That's because it's likely not earning much in the way of interest, so you're not losing much in potential gains on the money.
Avoid withdrawing funds from individual retirement accounts, or IRAs.
Generally, the IRS will tack on a 10 per cent tax for anyone who withdraws funds from their IRA if they're under 59 1/2 years old. Still, there are exceptions, including one allowing parents to withdraw up to $10,000 toward the first-home purchase of their child.
Even so, you'll have to pay taxes on that $10,000 at your normal income-tax rate. So if your child needs $10,000, you'll end up paying more to cover the portion lost to taxes.
Make a gift
Some parents may decide they can't afford to give their children a large sum of money, instead preferring to do it as a loan. But that can have an impact on the borrower's ability to qualify for a mortgage.
Mortgage lenders generally allow borrowers to use funds received as a gift from a relative to cover their down payment, closing costs or to add to their savings.
But if the money is being borrowed, the homebuyer is required to disclose that loan to the bank, which could alter their evaluation of the borrower's debt-to-income ratio. That's a calculus banks use to help determine the borrower's ability to pay back a mortgage.
If the funds are given as a gift, they don't count as debts that have to be repaid.
"When you apply for a loan they want to know how much money you have," said Erika Safran, a certified financial planner with Safran Wealth Advisors in New York. "If you're receiving gift, that person is going to have to write a letter saying that they don't expect it back."
Parents can help give their children a financial leg up on their home purchase, but there are other ways to do so beyond just giving them cash.
Local charities sometimes offer first-time buyers incentives to save by offering matching contributions. That's also a good approach for parents to take, say, by offering to match their children's savings toward a down payment.
Another option is to make sure their children are exploring down-payment assistance programs run by state and local housing authorities.
These programs can be found in all states and provide an average down-payment assistance of $11,565, according to an analysis of 2,290 such programs by real estate data firm RealtyTrac.
Most of the programs essentially lend the borrowers the money for the down payment, collecting on the loan when the home is sold, said Rob Chrane, CEO and founder of Down Payment Resource, which tracks the programs.
"There may be some programs that are targeted to certain census tracts or certain neighbourhoods, but basically there is something out there for everybody who qualifies," he said.