Residential real estate markets in coastal cities across the country have long been appreciating in value faster than other parts of the country. During the COVID-19 pandemic that growth has accelerated even faster due to low supply and increased demand from the millennial generation. As a result, buying a first home has become significantly more challenging for younger generations to achieve. Understandably, we’ve spoken to quite a few of our clients who have expressed an interest in helping their children and grandchildren buy a home. Here are questions we recommend you consider before you offer assistance.
Is there a maximum amount of funds that you would be willing to gift or loan to your loved one? The amount you are willing to give may not always be equal to the amount you are financially able to give, so it is important to talk to your financial advisor first to determine your ability to assist.
If you have additional children or grandchildren, do you plan to provide the same level of assistance when they are ready to buy a home? Most parents we speak to choose to give their children equal amounts. Of course, this also plays into the question above in terms of determining your financial capacity to give.
Now that you know what you’re willing and able to give, in what ways would you consider helping your loved one with the purchase? Below are five primary options. As you read through them, consider both the financial impact and, more importantly, the relationship impact between you and your loved one:
- Option A. Sole owner: You purchase the property yourselves and allow your child or grandchild to rent from you (or allow them to stay rent free or below market). Maybe you even implement a rent-to-own strategy. If they decide to move out, you may either sell the property, maintain it as a 2nd home, or rent it to the public. It’s important to note that this strategy does not enable your loved one to build credit.
- Option B. Co-owner of the real estate: You invest your money alongside your child or grandchild and the two of you jointly own the property. You would effectively be ‘going into business’ with your loved one sharing in profits, losses, and risk exposure. In our experience, this option can create the largest strain on parent-child relationships.
- Option C. Gift money to them without an expectation of the gift being returned: You have no ownership in the real estate nor exposure to liabilities and you are irrevocably transferring a portion of your net worth to your loved one. You can gift money to buy the property, or you can gift money to cover the mortgage (you can do this even if you choose to act as their lender, see d below). In our experience, this option can create the least strain on parent-child relationships.
- Option D. Act as your child or grandchild’s lender: You become the Parental Bank and loan your loved one the money they need to purchase the home. They would be responsible for making the mortgage payments to you. In the legal world this is called an intra-family loan and you have the ability to set the interest rate ultra-low. This would be a formal debt with a secured promissory note (i.e., if your loved one stopped paying, you can take possession of the property). Your loved one can now be an all-cash buyer since you are fronting them the money. You could also build on this strategy by adding a gifting element (like option c) and forgiving interest and/or principal over time. As your loved one’s income becomes larger and more stable in the future, they could refinance the loan with a traditional lender and pay you off in full.
- Option E. Co-sign a loan: Use your income to help your child or grandchild qualify for a larger mortgage. You become legally liable for the mortgage and if they are unable to pay, you must step in to cover the payments yourself. This loan would appear on your credit report and if payments are missed your credit score would be negatively impacted. In this option you are not fronting any money so it has the least financial impact from that perspective. However, you are taking on risk by becoming legally liable for the mortgage without the possibility of any upside.
We are often asked which of the five options are best. Unfortunately, there is no one-size-fits-all answer. It depends on your goals and values, financial resources, risk tolerance, personal preferences, and family dynamics. What we can do is rank these options across several spectrums to help you home in on the ideal option for you (please consider these general rules of thumb – your experience may vary):
- Potential financial upside for you, largest to smallest: A, B, D, C, E
- Financial risk, biggest to smallest: While the nature of the risk is different, E, B, and D are grouped together on the high side, then A, C on the low side.
- Potential for reducing your estate tax burden, highest to lowest: C, B, E, D, A
- Possible strain on family dynamic, most to least: B, D, E, A, C
As you can see, there is a lot to consider before approaching a family member to discuss the possibility of financial assistance in buying a home. Beyond the financial implications for everyone involved, there are also the unique family dynamics to take into account. Should you wish to have a conversation about assisting your child, grandchild or another loved one in purchasing a home, please reach out to your advisor to discuss. If you are not yet a client of Private Ocean’s, please contact me to schedule a consultation.
Private Ocean is a West Coast-based wealth management firm deliberately structured to give clients the intimate experience of a small firm while harnessing the power, depth and discipline of a much larger one. Formed in 2009, the firm has locations in San Rafael, San Francisco, and Seattle.
Zach Mangels, MSFP, CFP is a financial advisor. Zach’s goal is to provide a big picture for his clients that is both practical and forward-thinking. Zach holds an MS in Financial Planning from the College of Financial Planning and a BA in Psychology from the University of California San Diego.
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