By: John P. Napolitano, CFP®, CPA, PFS, MST

One trend that COVID-19 has accelerated is household formation by Millennials.

Household formation is an economic statistic that tracks young adults as they move from apartments to single family homes and then begin raising a family. I don’t know about you, but nearly every millennial that I know has abandoned their cheeky digs downtown for more space in the burbs. This has sparked a bit of a real estate boom and caused many young adults to seek assistance with financing that suburban home.

For those who want to help a young family member buy that home, there are right ways and wrong ways to do that.

The first issue is whether you’re giving a gift or making a loan. This matters on several fronts. If there is a bank involved with a primary mortgage, your loan to the buyers is probably not going to fly well. Most banks do not want to see any part of the down payment borrowed. Your young adult may be better off trying to qualify for one of the first time home buyer options and go with a very low down payment. 

A low down payment means that your child is likely to pay for private mortgage insurance (PMI) to further protect the bank. This is expensive and something that no one wants to pay. But if it means the difference between your loan approval or not, then do it. You may be able to pay down the mortgage at a later date with a loan from parents and apply to eliminate the PMI.

Co-signing on the loan is not a great option. When you co-sign, you’re as liable as the primary borrower.  If there are late payments, your credit will suffer. Your credit will also show as if you own the entire amount. If there is ever a default, you will be on the hook for all of the traditional default consequences.

If you’re able and would prefer the assistance to be in the form of a loan, do the loan right as if you were a bank. Lending money under an oral agreement where you allow them to pay you back whenever they can is the worst thing you can do. You should have a promissory note, with real payment terms and recording a mortgage so that the deed reflects this outstanding loan. You would want to do this formally correct for a few reasons.

First may be for income tax purposes. Your child may be able to deduct the interest on loans up to $750,000 if it is a true mortgage and used to acquire or renovate the residence.

A second and perhaps more important reason is for your protection. What if your child pre-deceases you, gets sued or gets a divorce? Without a loan document, your loan may get completely lost without proper documentation.

If you are unsure whether you want it to be a loan or a gift, make it a loan. At least you’ll be protected and then you can make your decision on a yearly basis by forgiving some of all of the monthly payments.

 

 

John P. Napolitano CFP®, CPA is CEO of US Wealth Management in Braintree, MA. Visit JohnPNapolitano on LinkedIn or uswealthnapolitano.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. John Napolitano is a registered principal with and securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.

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