What to Consider Before Loaning Your Child Money for a Down Payment on a House
According to the Census Bureau, the number of occupied housing units in the U.S. surged by 1.5 million over the previous 12 months fueled in large part by the number of millennials moving out of apartments and their parents’ homes. When it comes to paying top dollar for rent, Atlanta is the 13th most expensive market in the U.S., with average rent for a one-bedroom apartment coming in at $1,260, according to the March 2016 Zumper National Rent Report. This expensive rental market is spurring many first-time homebuyers, but where do they get the funds for down payments?
With roughly 13.5 percent of its population between the ages of 24 and 35, Atlanta is known as one of the best cities for millennials. Yet for many young people today, it’s difficult to purchase a home without some financial assistance. Aside from tough lending standards, and a strained housing inventory, college loan debt can make it difficult to come up with the funds for a down payment. As a result, many millennials turn to their parents or other family members for help.
If you plan on lending your child money for a down payment on a house, you may want to consider assuming the role of a commercial lender. Setting the terms of the loan in writing will demonstrate to your child that you take both your responsibility as lender and your child’s responsibility as borrower seriously.
While having an actual loan contract may seem too businesslike to some parents, doing so can help set expectations between you and your child and can help avoid issues down the road. The loan contract should spell out the exact loan amount, the interest rate and a repayment schedule. To avoid having to remind your child that a payment is due, consider asking him or her to set up automatic monthly transfers from his or her bank account to yours.
This type of loan documentation is also important for IRS purposes because there may be potential income and gift tax issues. For example, interest paid by your child will be considered taxable income, and if adequate interest is not charged for the loan, special imputed interest rules may apply.
If you don’t feel comfortable lending your child money, you may want to consider making a smaller, no-strings-attached gift that doesn’t have to be repaid. Currently, you can gift up to $14,000 annually per person under the gift tax exclusion. However, if you do gift money for a down payment, your child’s lender may still require him or her to put up some of his or her own money, depending on the type of mortgage chosen.
Keep in mind that lending money to family members can be a tricky proposition. Before entering into this type of financial arrangement, you should take the time to carefully weigh both the financial and emotional costs.
For more about how millennials approach renting vs. buying, read a recent article by SHWM here.