The real-estate market has been booming. So much so, that it seems like everyone and their mother is buying a new home, and I mean that in the most literal way.
In high-priced housing markets mom and dad are shelling out cash and helping their adult children live the American Dream of homeownership. Parents opening up their wallets and assisting with home loans has been going on for generations, but the trend is on the rise according to the 2018 NAR Home Buyer and Seller Generational Trends Report.
In Boston, where I practice real estate, I am seeing it more and more with first-time homebuyers. I would estimate that close to half of my millennial buyer clients are receiving contributions from their parents or grandparents.
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This arrangement can be tricky at times. How do you structure the deal from a financial standpoint? What considerations should be made?
There's more than one way to approach it. Here is how my young buyers have navigated purchasing a house alongside their parental units.
Develop a plan before you start shopping — and leave the family drama out of it
Being in the position to give or receive financial assistance from a family member is a good problem to have. Sometimes parents and kids can lose sight of this during the home buying process when emotions run high.
As a real estate agent, I often get stuck in the crosshairs. When it comes to bringing family dynamics into the equation, having a solid plan and communicating well are key.
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Read more: I'm a real estate agent and investor — here are my 8 best pieces of advice for first-time homebuyers
First, figure out a financial strategy that makes the most sense. The options that I mention below provide a brief outline of some common approaches. You'll want to speak with a lender, financial adviser, CPA, and attorney to hammer out the details. While it is only natural for parents to want to lend a helping hand, they shouldn't put their own financial situation in jeopardy.
Next, have an open discussion about everything before you start the house hunt. For example, what is the motivation for the loan? As a parent, you may feel a sense of pride for being able to provide for your child or you may feel like your child is taking advantage of your generosity. On the other hand, some children feel guilty about getting a "handout" and indebted to their parents. It's best to get these feelings out on the table sooner rather than later.
Read more: A realtor who works with first-time homebuyers reveals a common mistake millennials make when they're house shopping
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Another major point of contention is how involved the parents are going to be during the buying process and throughout ownership. It's all about the control factor and who gets to call the shots. You want to talk it out prior to sinking time into home shopping. Trust me, a home inspection is not an appropriate place for a family feud.
Plenty of first-time buyers have been able to afford properties they otherwise wouldn't have by leaning on family. If you are fortunate to have this option, you can spare the drama with some proactive planning.
Many millennials get cash gifts and loans from parents — here's how it works
Receiving gift funds towards a down payment
The most popular way for parents to get involved is by providing gift money. Chris Butts, a loan officer at Leader Bank, estimates that about 40% of his first-time buyer clients use some sort of gift money ranging from a few thousand dollars to a substantial percentage of the purchase. "Gift money is exactly what it sounds like – the parents pass along a sum of money onto their child without expecting reimbursem*nt."
This approach makes the most sense for those who can afford the monthly payments, but need help overcoming the upfront costs associated with buying. Most lenders allow borrowers to use gift money for a down payment or to foot the bill on closing costs.
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The process is quite straightforward. First the lender will request proof of funds from the parents such as a document or bank statement that shows cash on hand. Then, copies of the money transfer from the parent to child will need to be recorded. Lastly, the mortgage company will need a letter from the donor (i.e. parent) stating that the money is truly a gift and not a loan.
Tapping the bank of Mom and Dad
Most homebuyers work with traditional lenders such as a bank or credit union to take out a mortgage, but parents with liquidity can also be an excellent source for private lending. Family loans can be a win-win for everyone involved.
Private lending allows buyers to place bids on properties without a finance contingency. In a world where cash is king, this is huge. Buyers also can side-step many of the mortgage fees involved in a typical transaction such as the appraisal, application costs, etc. Parents reap the benefit of a recurring revenue stream in the form of interest.
Mom-and-pop mortgages can be an attractive solution if parents can afford the cash outlay. A lawyer can structure a family loan in many different ways. Having the flexibility is particularly beneficial to borrowers with low FICO scores or little credit history who may not be able to qualify for a loan through a bank. Of course, in order for the loan to be legitimate, it needs to be registered with the state and is subject to IRS scrutiny just like any traditional mortgage.
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Partnering with parents
Another route to consider is partnering up. According to Butts, who specializes in residential mortgages, "This may be the easiest option if the buyer needs the parent's income and credit history to qualify for the loan." Under this arrangement, all parties have ownership interest in the property and are responsible for repaying the loan.
This situation works particularly well for families teaming up to buy a vacation getaway or multi-family home where all parties will reap the benefits of ownership.
However, parents can also be a non-occupant co-borrower, meaning that although they do not live at the property, their names are on the deed. Co-borrowing or in some cases co-signing, have become an attractive option for families with college students. In lieu of room and board, parents are buying a "Kiddie Condo," a flat or single-family home near campus. Not only does this give young adult students a taste of homeownership, it also provides the family with additional income if extra rooms are rented out.
Dana Bull is a Massachusetts REALTOR® and real estate investor. She specializes in millennial and first-time buyers and also writes a column for RealEstate.com. You can learn more at www.danabullrealtor.com.
