It’s fairly common for parents to help their children buy a home. But sometimes, adult children are in a position where they want to help buy a home for their parents.
It may be that the children have been successful and want their parents to have a better home than they do now. Perhaps the current housing no longer meets their needs. Maybe the parents live some distance away and the children wish to have them nearby, but housing costs in the new location are considerably higher than where they live now. Or the parents may need a retirement dwelling but can’t afford to make the move on a fixed income.
Basically, you have three options:
1. Buy a home for them outright and allow them to live there.
2. Assist them in buying a home if they’d have difficulty obtaining a loan by themselves.
3. Buy a home and rent it back to them at an affordable cost.
Coupled with these are questions about financing, title, taxes and the eventual sale or inheritance of the property, which vary among the three options.
1. Buying the Home Yourself
If you’re planning to finance the purchase of the home yourself, you probably have significant assets to draw upon. In that event, Malcolm Hollensteiner, director of retail lending products and services for TD Bank in Cherry Hill, N.J., recommends leveraging those assets rather than financing the property through a regular mortgage.
“If the financing is in their (the adult child’s) name but they don’t intend to occupy it as a primary residence, the lender will view it as a second home or an investment property,” Hollensteiner said. That could mean paying a higher interest rate and more in closing costs than on a primary residence.
If the buyer has a lot of equity in their own home, Hollensteiner suggests that they might wish to tap that instead. A cash-out refinance would likely provide a lower interest rate than they could obtain with a mortgage on a second home or investment property.
If drawing upon your own home equity or the equity in other property that you own isn’t an option, you could opt to buy your parents a home with a regular mortgage on that property and make the payments yourself. If the mortgage and home are in your name, that means it would be considered a second home, which as noted above, would generally mean you’d pay higher rates and fees than on a mortgage for a primary residence. Down payment requirements are likely to be higher as well.
On taxes, you can still deduct the mortgage interest on both homes, up to a total of $1 million for the combined mortgage balances on both. You can deduct the property taxes on both, too. However, if you already own a second home and have mortgages on both it and your primary residence, you can only claim the mortgage interest deduction on two of the three properties.
One of the obstacles to this approach is that if you’re going to obtain a conforming mortgage for a second home, lenders may require that it be located at least 50 miles away from your primary residence. That doesn’t work so well if your parents are moving to be close to you or if you’ll be helping to provide care.
There is an option called the Family Opportunity Mortgage, which is authorized by Fannie Mae and Freddie Mac and designed for children buying a home for an older parent who is unable to work or qualify for a mortgage on their own. It waives the 50-mile requirement and allows the loan to be qualified on terms similar to a mortgage on a primary residence, meaning a lower interest rate and a down payment of as little as 5%, rather than the 20%-25% commonly required on second homes. However, it is a niche product and it may be difficult to find a lender that offers it.
2. Helping Them Buy a Home
Another possibility is to assist your parents in buying a home, rather than buying it outright. Obviously, this has the advantage of putting less financial strain on you and allows your parents to own their home outright.
If your parents can’t qualify for a mortgage on their own, but can cover all or some of the mortgage payments and other expenses, you might consider taking on the role of a non-occupant co-borrower, also called a co-signer. While this is more commonly associated with car loans and other smaller obligations, it can also be used on a mortgage.
When you put yourself on the loan as a co-borrower, you’re accepting responsibility for ensuring that the mortgage payments are made, the same as your parents. If they can’t pay the loan one month or for an extended period of time, you’re promising to step up and cover it.
Mortgage programs for non-occupant co-borrowers vary. Hollensteiner said one of the best is through the FHA, which allows down payments of as little as 3.5%. When qualifying co-borrowers on an FHA mortgage, the rule guidelines lump the incomes of all borrowers and co-borrowers together when calculating debt-to-income ratios in qualifying for a mortgage. This makes it easier to qualify for a loan.
Other loan programs, Hollensteiner said, may have different guidelines. The occupant borrowers may have to meet their own criteria for debt-to-income ratio separate from the co-borrowers. So instead of being able to count the parent’s and child’s income together toward qualifying for the loan, the parent may have to meet certain minimum income standards of their own.
If you’re financing the purchase through a mortgage, the question of whose name is on the loan will have a bearing on what’s the best type of loan to get. Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage and a mortgage adviser with C2 Financial Corp in San Jose, Calif., notes that a loan that works well for a child purchasing a home for their parents might not be the best choice if the parents are the ones with their names on the note.
Fleming, whose clients come from the Silicon Valley region, says he sees a lot of borrowers with high net incomes and occasional windfall earnings – the type of people who are likely to be in a position to buy a home for their parents.
“I’m a big believer in adjustable-rate mortgages in those circumstances,” he said.
For someone with substantial assets, an ARM offers two significant advantages, Fleming said. First, the interest rate is lower than on a fixed-rate mortgage, at least for the initial period. Second, this means more money can go toward paying down the principle rather than going toward interest payments.
“If you have disposable income and rates go up, you can absorb it,” he said.
The opposite would be true if it were parents on a limited or fixed-income who were taking out the loan. Fleming noted that in that case, they would be in a poor position to adjust to an increased monthly payment if rates were to rise, so a fixed-rate loan provides better security.
3. Buying a Home to Rent to Them
Yet another possibility is to buy a home for your parents, then rent it back to them at a cost they can afford. This may be a solution if the parents can’t qualify for the mortgage but can handle the cost of the payments, or if they wish to pay some or all of their own housing expenses.
If you rent the home to your parents, it will likely be treated as an investment property for lending and tax purposes, which means a higher down payment and interest rate on the mortgage. You’ll also have to treat their rent payments as income on your own taxes. On the other hand, you’ll be able to deduct costs for repair, maintenance and depreciation, in addition to deductions for mortgage interest, property taxes and property insurance.
If you rent it to them at a below-market rate, you can’t deduct the difference between what they pay and the market rate as an operating loss. However, Fleming said you may be able to count the difference as a passive loss against any capital gains realized when the property is eventually sold.
Renting a property to your parents for their benefit can open up a lot of other financial, tax and legal complications that are too involved to go into here. If you’re considering this approach, it’s essential to get good legal advice on the implications.
Whose Name Goes on the Deed?
Regardless of how the home purchase is financed, there is one other major issue to consider – whose name goes on the deed. Putting the home in your parents’ names, for example, could jeopardize their eligibility for Medicaid, if they may be in need of that program. The home could also be considered a countable asset that might have to be sold to defray Medicaid nursing home expenses.
However, having the property in your parents’ names could allow you to escape capital gains tax consequences that a second home would be subjected to, should the property rise in value. However, there could still be issues related to the inheritance of the property when the time comes.
Fleming said most attorneys he knows recommend that people buying a home for their parents place the property in a trust. That allows the parents to enjoy the use of the home and provides a mechanism for the home to pass on to the child or children with minimal complications. Laws do vary by state, however, so it’s essential to get good legal advice before pursuing this route.
Whether you’re purchasing the home on your own, or co-purchasing the home with your parents, it’s important to check your credit in advance to make sure it’s optimal to help you qualify, and possibly with good rates. Pull your credit reports, which you can get for free every year from AnnualCreditReport.com, to look for mistakes or any other problems that you can resolve first. It’s also helpful to pull your credit scores to see where you stand, and to determine whether you need to take some time to build your credit before you apply. You can get two of your credit scores for free every month from Credit.com, along with a plan to help you build your credit if you need it.
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