Helping the Kids Is an Unending Dilemma for Parents
For many parents, it seems the financial burdens of child-raising never end. First it was room and board, then it was college and now, for a substantial number, it’s helping with a home purchase.
The problem comes as no surprise to economists. House prices shot up during the 1970s and 1980s and, although they have declined substantially in most Southland communities, they are still a hefty bite.
At the same time, wages for younger people, especially those trying to pay back student loans, have not kept pace, and the spending habits of many young adults today reflect a lifetime of instant gratification.
Many young couples, of course, land good jobs, live frugally and are able to manage the down payment and mortgage without help. For others, though, saving comes hard even when they earn a good income. So they do what they’ve always done--turn to Mom and Dad, or to Grandpa and Grandma.
How should the older generation respond?
It’s a tough call. Parents naturally want to see their children settled, and most would like to help. But there are other considerations. Parents today must worry about their own retirement, and many face the prospect of caring for their own parents.
Grandparents likewise must watch the bottom line, since they want to avoid becoming burdens to their children if they can.
And there is the question of just where to draw the line.
“I’ve heard some really complaining parents,” said Kathy Jatras of Organized Finances Unlimited, a financial planning firm in Arlington, Va. “They say all they seem to do is give, give, give, and the kids never seem to cut the umbilical cord. They expect constant help and never live within their means. College credit cards start it. The parents are pretty frustrated.”
Still, the pressure to help is strong, and many parents and grandparents do. Nevertheless, those considering it should carefully consider the personal, legal and tax issues involved.
“First, you have to be very sure [the kids] can afford this house,” said Alexandra Armstrong of Armstrong, Welch and MacIntyre Inc., financial planners in Washington, D.C.
Make sure they aren’t looking at a $250,000 house when they have income for a $150,000 house, she said. Remember that the mortgage and real estate taxes are only the beginning of home ownership costs. There is also insurance, maintenance and other expenses, which tend to get bigger as the house gets bigger.
The next question is whether to help with the down payment or the mortgage. That depends in large measure on the cash situation of both the kids and the older folks.
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In her experience, Jatras said, young couples have less trouble qualifying for mortgages than accumulating the down payment. If that’s the case, there are two choices: a gift or a loan.
Federal gift tax law allows anyone to give someone else up to $10,000 a year with no tax consequences. If both parents are alive, they can give a child $20,000 in a year, and if the child has a spouse, the total tax-free gift can rise to $40,000.
For well-heeled older people, this is a good device for transferring wealth to the younger generation. Grandparents with plenty of money should be doing this and giving other gifts as well, planners say. Doing it in a will creates the risk of much higher taxes, including the so-called “generation-skipping” tax that imposes an extra levy on people who leave more than $1 million to grandchildren or younger descendants.
For the not-so-well-off, the question is whether you can do without the money. And for both rich and not-rich, there is the question of whether you are making things too easy for the kids.
If there is any doubt, planners say, consider a loan or a combination of a loan and a gift. “You can always forgive the loan” later on if you choose to, said Armstrong.
Some mortgage lenders don’t want home buyers borrowing their down payment, so you should make sure your proposed arrangement is acceptable to the lender.
Also, the loan should be formal and legally binding and at a current market rate of interest. That way, the interest payments will be deductible to the kids, though taxable income to the older folks. If the loan is not binding or the terms are too favorable, the Internal Revenue Service may deem it a gift. If you want to make the loan interest-free or at below market rates, check with an accountant or other expert; the tax rules on such transactions are complex.
If the mortgage is the problem, you can consider co-signing the note. This may allow the kids to qualify when they otherwise wouldn’t or in some cases to get a better interest rate.
Co-signing requires no cash and, as long as the kids keep up the payments, there are no tax consequences to the older folks. The interest payments remain deductible to the kids.
Co-signing does involve risk, though. If the kids default, the co-signers will be on the hook. In an era of widespread job layoffs and frequent divorces, the possibility can’t be ignored.
That’s not all bad, though. As co-signer on the mortgage, you will want to keep up with the young family’s situation, and as a parent or grandparent, you should be concerned anyway. Knowing how things are going may put you in a position to step in as a problem is developing and help head it off.
There are some fancier alternatives for helping the kids buy a house. Parents can actually become joint owners of the property with the kids or they can form partnerships to buy the house. These devices were popular during the 1980s but have become less common in recent years.
In addition, planners and real estate experts have found that those arrangements often lead to confusion and friction. In the days of rapidly rising house prices, that was perhaps more tolerable since everybody probably was making money off the deal, but today that incentive is greatly reduced.
“What I have found with parents and children is if you can keep it as separate as possible, that works better,” Jatras said.
