Open Before Closing
It was 1983 when Rick and Linda Humphrey, married for six years and the parents of 18-month-old Jessica, got serious about buying their first home.
“We found an 800-square-foot, two-bedroom house in Gardena for $95,000,” said Rick Humphrey, now 47 and a graphic design specialist at the Aerospace Corp. in El Segundo. “We were lucky,” he said. “We found a home we liked with an assumable loan.”
But getting into that first house still would have been a stretch for the young couple. Then Linda’s parents surprised them by offering a gift of $25,000 toward their purchase.
“I don’t think we could have qualified for the loan without their help,” Humphrey said.
And that gift from their family 16 years ago has had a long-term effect on their lives, he added, eventually allowing them to move their growing family to larger quarters.
“A few years later, we added on to the house in Gardena, and we were able to sell it for $150,000 in 1994,” Humphrey said. The couple--then with three kids--bought a 1,200-square-foot, three-bedroom home in Torrance for $215,000.
“Having this help gave us a bit of breathing room,” Humphrey said. “We didn’t have to put every last penny from our savings into the down payment.”
If a parent wants to help an adult child with that first home purchase, there are several ways to do it, according to local realty and lending experts:
* Giving a gift of money. This is a common way to help overcome the down payment hurdle.
* Lending money. This is accepted by some, but not all, lenders.
* Co-signing the loan. Parents can provide the benefit of their more-established credit rating to help clinch the deal.
* Equity sharing. Parents can share in the investment and have their names on the deed.
Helping adult children get a foot in the door of that first home is becoming increasingly common, especially in Southern California, where the down payment alone can amount to a serious chunk of cash.
“About 20% of the first-time buyers I work with receive some sort of financial assistance from their parents to help with the down payment,” said Dorothy LaRose, a broker associate withShorewood Realtors in Manhattan Beach.
“Sometimes parents put up all of the down payment, especially with some of these 5% down programs,” she said.
Each option has its advantages--and pitfalls. So it’s important to make sure all the people involved weigh the options and communicate their expectations before signing on the dotted line, advised Shari Steiner, a real estate broker and coauthor of “Steiners Complete How to Talk Mortgage Talk” (1999, Independent Information Publications, $12.95, in bookstores or call [800] 444-2524).
Making a Gift
If you choose to give a gift of money to help a child with a down payment or closing costs, keep in mind how much you can give before Uncle Sam starts getting a gleam in his eye, said tax specialist Laura B. Ellison, an enrolled agent in Huntington Beach.
For the 1999 tax year, an individual can make a gift of up to $10,000 to another person without the donor paying a gift tax or filing a gift tax return, according to Ellison.
For example, if you and your spouse wanted to help a daughter and her husband with a down payment, you could give $10,000 to your daughter and another $10,000 to your son-in-law. Your spouse could do the same, for a total of $40,000.
In terms of taxes, there is no limit to the number of $10,000 gifts a person can make to different individuals each year, Ellison said, so parents can help more than one child in the same year.
It’s important to know upfront that giving a monetary gift to your child isn’t the same as making a donation to your favorite charity, Ellison emphasized. “The gift is not deductible by the giver.”
On the other hand, such a gift is not taxable for the recipient.
What if you want to give a larger amount? If your previous gifts were no more than $10,000, “you can give up to $650,000 in the 1999 tax year without owing any taxes on it in this tax year,” said Ellison.
Your gift will, however, have an impact on how your estate is taxed at the time of your death. Under current law, there is a $650,000 exemption to the estate tax. The exemption will be increased yearly until it reaches $1 million in 2006.
Another thing to keep in mind if you’re considering making such a gift: It’s just that--a gift.
Experts recommend looking at your motives for giving a financial gift to your child. If you’re concerned about what might happen to the money if the kids get divorced, for example, this may not be the option for you.
The trick here is to be able to give the money if you wish and then let it go.
But before you let it go, make sure you spell out, in writing, that the money is definitely a gift, advised Steiner. Doing this can help avoid serious family misunderstandings down the road.
Also, note that if you do provide a gift of money, the mortgage lender will ask you to sign a “gift letter” stating that the money is a gift and showing where it originated, said Tony Pitko, senior loan consultant at Washington Mutual Bank’s Residential Loan Center in Torrance.
Parents used to have to show copies of financial statements to prove where the gift money came from, but this is now considered personal information and is not required, because the parents aren’t the ones applying for the loan, Pitko added.
“The borrower just has to show that the money has been transferred to his personal account or to an escrow account,” he said.
House-hunters will probably have a tough time landing a conventional home loan if Mom and Dad are lending the money for the down payment, according to our experts.
Lenders don’t like borrowed down payments because it must be repaid and that may impair the borrower’s ability to pay the mortgage.
But if the buyer qualifies for an FHA loan, immediate family can provide a loan of up to 100% of the down payment and closing costs, said Teri Turquand, branch manager for the Torrance office of Countrywide Funding Corp.
Another advantage for first-time buyers: FHA loans, because they’re guaranteed by the federal government, usually have lower interest rates than conventional loans, according to Steiner.
But there’s a downside too: “[FHA loans] have lower ceilings on dollar amounts and loan-to-value amounts, either of which may rule out these loans,” Steiner said.
Also, FHA loans may have more stringent borrower qualifications, more paperwork and a longer turnaround time.
But the fortitude required to get such a loan may be worth it if Mom and Dad are willing to lend the down payment.
Of course, just as you would when making a gift of money toward a down payment, you’ll want to talk with your tax advisor about the tax consequences--for both parties--of making such a loan, advised Ellison.
If your child needs a bit more credit oomph to qualify for a home loan, you may choose to co-sign the mortgage application, whether you also help out financially or not.
Like almost everything else in the mortgage business, this option is appropriate in some cases but not others, said Bob Sheets, owner of Golden West Mortgage in Encino.
“Most conventional loans of up to $240,000 are eventually sold by the lender to Fannie Mae and Freddie Mac,” Sheets said. To be able to resell their loans to these agencies, lenders must conform to government guidelines when qualifying borrowers.
Here’s the kicker: If the primary borrower can’t come within at least 10% of qualifying for the loan, Fannie Mae and Freddie Mac won’t allow a parent or parents to co-qualify for the loan without occupying the property, Steiner said.
So how can a parent become a co-signer without moving in with the kids?
“Non-Fannie Mae lenders, often called portfolio lenders, are not as stringent in their guidelines,” Sheets said. “In that case, a co-borrower doesn’t have to occupy the property.”
Also, Sheets added, “a portfolio lender can usually provide an adjustable-rate loan, which may make it easier for first-time buyers to qualify.”
Loans for more than $240,000--called “jumbo” loans--exceed the Fannie Mae-Freddie Mac cap and are not subject to these conditions. However, many jumbo lenders use Fannie Mae and Freddie Mac underwriting guidelines, Sheets noted.
In that case, do Mom and Pop still need to move into the spare bedroom to enable the kids to qualify for the loan? Probably not.
“Co-occupancy is often not a requirement in this case,” Steiner said. “A good mortgage broker can find a fairly competitive mortgage rate without that requirement.”
Another consideration for parents who choose to co-sign a loan, Sheets said, is their own ability to obtain a loan in the future. “It may be difficult to buy property when you already have another loan on your credit record,” he said, because such an item on a credit report can make your debt ratio look worse than it is.
“But if you can show copies of your child’s canceled checks, indicating that he or she is making regular mortgage payments, lenders will take that into account,” Sheets added.
Equity Sharing
Equity sharing “creates more of that feeling of ownership,” said Steiner. If you decide to share equity in a home with your adult child, you contribute financially, and the names of all parties are listed on the deed.
When the house is sold, the parent receives money from the proceeds based on percentage of ownership, assuming that the house goes up in value.
It’s important to keep in mind too that when the house is sold, the profit will represent a taxable gain for the parents, who are seen by the IRS as investors.
For the children, who have made the home their personal residence, “there will be no taxes owed on their share of the profits as long as their gain is less than $250,000, if single, or $500,000, if married, and they have lived in the house for at least two years,” Ellison said.
Also, although the parents may be liable for a portion of the mortgage interest and the property taxes, only those who actually pay these items can take a tax deduction for them, according to Ellison.
Having a parent’s name on the deed can further complicate matters in the case of death or divorce. And if a parent needs money for medical bills or assisted living in later years, having a substantial amount of money tied up in a child’s home could be a problem.
The bottom line? If you’re considering any of these arrangements, the experts recommend the following:
* Keep Uncle Sam in mind.
Seek the advice of a tax consultant regarding how to hold title on the property. Take time to understand all the possible tax implications of your decision.
* Make it official.
Consider hiring a real estate attorney to draw up the paperwork. The cost will probably run between $300 and $500, according to Steiner.
* Know your child.
Make sure you’re comfortable with your child’s ability--and willingness--to make mortgage payments on time. If your name is on the loan, your credit rating is on the line too.
In Rick and Linda Humphrey’s case, receiving help from their family for the purchase of their first home has made a big difference in the quality of their lives and has made an already close family even closer, said Rick Humphrey.
“We’d never be in the home we’re in today if it hadn’t been for my in-laws’ generosity,” he said. “It was a wonderful gift and we’ve never forgotten it.”
Kathy Sena is a freelance writer in Manhattan Beach.
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Money Issues Can Fray Family Ties
Blood may be thicker than water, but family ties often aren’t enough to keep even well-intentioned relatives from butting heads over money.
That’s why it’s impossible to communicate too much when you’re sitting down with a parent--or an adult child--to talk about assistance with a home purchase.
Eight years ago, Janis Hashe, then in her mid-30s, asked her mother to co-sign the loan for her Los Angeles home. “We had the world’s best intentions,” she said. “We had a loving, mutually respectful relationship, and we still do.”
But in the eight years since Mom signed on the dotted line, “we’ve gotten down to it a few times, Mother and I,” she said, laughing. Understandably, Hashe, a successful magazine editor, “didn’t like the idea of my mother controlling my financial future.”
But because her mom’s signature is on the original loan, “I can’t take out a home-equity loan, refinance the house--anything--without her signature,” she said.
And that’s a continuing source of frustration, Hashe added, even though she’s grateful that her mother was able to help.
