Here are three of the most common strategies for those looking to help family members get their foot in the door, each with its own advantages and caveats.
Cash gift
How it works: The most common approach, by far, is for parents or other family members to gift money for the down payment. This simplifies the rest of the process, as it doesn’t require the benefactor to be on the mortgage or draw up additional paperwork. Any individual can gift another person up to $14,000 a year without having to pay a gift tax — which can be as high as 40 percent — or file a gift tax return. That means a couple could give another couple as much as $56,000 in any one calendar year; it’s not uncommon for parents to make this maximum gift over two calendar years.
What many buyers and their parents don’t realize, is they can gift an amount over the $14,000 annual gift exclusion by using some of their lifetime exemption, which is $5.49 million in 2017. If this is done, then a gift tax return must be filed in that year (consult your tax professional before making any gifting decisions).
What to know: Assuming you are getting a mortgage, lenders will want to see the source of your down payment funds. Be sure that you have a clear paper trail to share with the bank, including but not limited to:
- The donor’s name and address
- The donor’s relationship to the homebuyer
- The dollar amount of the gift
- The date the funds were transferred
International gifts can add further challenges because of anti-money laundering laws and regulations. Check with your lender first if you plan to receive gifts from overseas.
Depending on the type of mortgage and property, you may need to show that some of the funds are coming from your own savings. Conventional mortgages for multi-family dwellings (two- to four-unit properties) typically require five percent down from the buyers. In the case of a cooperative, such as in New York or the San Francisco Bay Area, a co-op board may have its own criteria for the size and source of your down payment.
Just as important as what the lender requires is what you can afford. Even if you get help with the down payment, you’ll want to make sure that your ongoing housing expenses are still well within your limits; we typically recommend that monthly housing costs be no more than 28 to 32 percent of your gross monthly income.
Personal loan
How it works: Parents or other family members can lend money for a down payment or the entire cost of the home using an intra-family loan. In markets that are especially competitive, buyers are making all-cash offers with the help of such family loans. For some families this can be a win-win: The buyers get the help they need to get into a home, while the lenders may be able to earn a better interest rate than they can expect to receive from conventional income investment.
What to know: The familial lender will want to work with an attorney to prepare the correct documentation and ensure that the interest rate associated with the loan meets IRS requirements to consider this transaction a true loan — as opposed to a gift. If earning interest is not a priority, the holders of the loan can waive interest by using their annual gift exclusion amount of $14,000 or forgive some of the payment.
Keep in mind, however, that some lenders may not approve a loan if some or all of the down payment is borrowed as having an additional large debt to repay can be viewed negatively.