If your child turns to you for help with a home purchase, it can be difficult to turn them away. Before agreeing to sign on the dotted line, consider whether the money would be a loan or outright gift, how the money will impact your own financial plan, and how the money may impact the parent-child relationship.
Many children look to parents to help them with a home purchase because the “bank of parents” is friendlier and more forgiving than a financial institution. There are also direct advantages for parents as the lender. If you cover your child’s mortgage payments and co-sign the loan, you are eligible to deduct the mortgage interest on your taxes.
However, if you provide children a loan but are not a co-signer, you can’t deduct the interest. The maximum amount of debt that can be deducted as of tax year 2018 is $750,000. If you secured the loan in 2017 or earlier, the previous limit of $1 million still applies to your deduction.
If, as a parent, you decide you would like to support your child’s home purchase, you should first talk with a financial adviser to determine what amount is realistic given your finances and retirement goals. An adviser can provide clarity around how the money would impact your plan. Parents need to also be prepared for that loan to turn into a gift, because there is a greater default risk.
Providing a financial loan or gift can also create complexities in family dynamics. All parties must recognize that there is now a new business relationship.
What happens if the child can’t pay on time? Will it be discussed over family dinner? Is the parent comfortable following up with their child about payments that are overdue? Are there penalty charges for late payments? Are there other children or family members who will seek similar loans or gifts, and if so, are parents able to offer the same financial assistance to them?
To help combat these questions, you should meet with a CPA or lawyer and establish a contract that both parties sign. This helps set clear expectations to keep everyone aligned and happy with the partnership.
With historically low interest rates, there are a multitude of options for young adults to get favorable loans today. So if you aren’t able to provide a loan, encourage your child to look into loans at a bank or credit union and look into tax credits in their local area.
In some cases, a more traditional loan could be the best option. For example, if your child is a veteran, military personnel, reservist or member of the National Guard, they may be able to apply for a VA loan, which provides easier financing with no down payment and more lenient credit and income requirements.
Parents seek to help support their children, but with other options available, their support should not come at the expense of their own retirement. If you can afford to help your child buy a home without risking your future, set clear expectations upfront. If set up properly, it can be a win-win situation for both parent and child.