Buying a house requires a minimum down payment between 3.5 percent and 5 percent. And unfortunately, it might take several years to save up for a purchase, which can significantly delay dreams of ownership. However, in an effort to help your children realize their dream sooner, you may decide to lend them money to buy a house.
Lending a child money to buy a house is not uncommon. In fact, “7 percent of first-time homebuyers in 2013 received a loan from a friend or relative, typically their parents, to help purchase a home,” according to the National Association of Realtors.
However, despite the fact that this is common practice, there are several things you need to take into consideration before financially helping your child purchase a home.
How’s His/Her Credit and Job History?
As much as you want to help your child, seriously consider whether he is responsible enough to handle a mortgage loan — and whether he’ll actually pay you back.
Now, if your child maintains steady employment and always takes care of his financial obligations, chances are that he’ll be responsible with funds and repay you and the bank as agreed. However, if he jumps from job to job, or if he barely qualified for a mortgage because of a lower credit score, lending him cash to purchase a house has more risks than benefits, and there’s a chance that he won’t pay you back.
Is It a Loan, or a Gift?
Be very clear when giving your child money to buy a house. In other words, make sure he understands what’s expected of him. If you’re lending money, create a written contract outlining the terms of the loan, including the interest rate. This way, there is no misunderstandings, which can alleviate any rifts with your child. When there’s poor communication, you may give your child money expecting him or her to repay funds, whereas your child may view funds as a gift.
Make Sure You Understand Gift Tax Rules
If you don’t expect your child to repay funds, the cash you give is considered a gift by the IRS. And unfortunately, if you give your child more than $14,000 per year, you’ll have to pay a federal gift tax.
The good thing about the gift tax is that each parent can give their child up to $14,000 without incurring a gift tax. Therefore, together you and your spouse can gift a child up to $28,000 (per year) to buy a house and avoid the federal gift tax.
Can You Afford It?
It’s wonderful that you want to help your child buy a house, but you shouldn’t help at the expense of saving for your own retirement. Pulling money from your 401(k) or an individual retirement account can significantly reduce your earning potential, ultimately impacting how much you’ll have when you’re ready to retire. Not only will you reduce the value of your retirement account, you’ll also pay an early withdrawal penalty plus income taxes on the withdrawal. If you’re relatively young and have plenty of time to recoup this money — and you’re okay with the financial hit — go for it. But if you’re near retirement age, it’s probably best for your child to save the money himself.
Homeownership is an amazing feeling; and understandably, your child is eager to get the keys to his own place. Even so, before you jump in and rescue the day, consider whether this is the best decision for your child, and your finances.
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