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Gift or Loan

How Family Money Can Help You Buy a Home

If you’re a buyer on a tight budget, your family may be able or willing to help you with your downpayment. If that’s the case, lucky you!

I know financial support from family is not an option for every buyer and I have many articles about other options on my website, but if you do fall into the category of getting down payment money from your family, this is a useful guide.

First thing to decide: should you or shouldn’t you accept their help?

It’s help that many first-time buyers do welcome, especially if coming up with a down payment or qualifying for a lower interest rate is going to delay their dream of home ownership.

If you have willing family members who have the finances or who may want to see you enjoy your inheritance now, then it’s worth the time to see if this is a viable financial option for you (and them).

The big question is whether it will be a gift or a loan. These are two very distinct options and are handled differently from beginning to end.

You and your family members will want to consult with experts on tax law and real estate law so that all the “i’s are dotted” and the IRS won’t be questioning this intrafamily agreement.

It’s a Gift — $16,000 tax free! And if you are married each person can receive up to $16,000 for a total of $32,000.

A gift is just that, a present with no strings attached. It’s not a loan at all or even considered income. And you do not have to pay back anyone. Ever.

And, yep, you and your spouse could get up to $16,000 in one year and up to $32,000. That could be a nice down payment.

However, you and your parents or other family members still need to follow some guidelines to avoid any tax implications and still meet lender requirements.

Of course, check with your own accountant to double check your specific tax implications, but a general rule of thumb is:

• Parents can each give up to $16,000 to a child and another $16,000 each to their child’s spouse per year without facing a gift tax. That’s a total of $36,000 total per year for a couple. If both sets of parents gift $16,000 to each spouse you can end up with $72,000.

• If the gift is recent and is for the sole purpose of buying a home, a lender needs to see a signed agreement from parents stating that they have given their child a specific amount of money as a gift and don’t expect repayment.

In this situation, a lender wants the buyer to prove the origin of this new lump sum of money, which is usually put toward a down payment. The lender needs to fully understand any borrower’s complete finances and any risks, and this letter assures them that you are under no obligation to pay back this gift.

Parents or a family member can send the money directly to the settlement agent. That amount needs to match the amount stated in the letter. Many family members who lend money this way are happy to know that they are helping you buy a home and have some control over where the money is going.

I’m not a licensed account, so be sure to check with yours about what the tax implications might be for you and your family.

Early Inheritance

If you and your parents are really organized, the tax-free gift giving can start earlier. With some preplanning, your parents can each gift you $16,000 per year over several years into an account in your name. Or double that if you’re married!

In this situation, the gifted money can become more “seasoned” in your account, well before you even start looking for a home or begin working with a lender. It essentially becomes your money, and no lender letter is required down the road.

However, the potential downside for your parents or other family members is that they now have no control on how you spend this money. It might not ever be used for a down payment on a home at all. It’s really up to you.

But that’s a serious family discussion that you need have if you all decide to go this route. It’s important that everyone understands all of the potential scenarios to avoid any family regrets over this gifted money or early inheritance.

Intrafamily Loan

Rather than gifting money, a family member can lend you money to purchase a home. That means you do have an obligation to pay back this money.

It’s a little more complicated to set up this family loan, but it can be a win-win for both sides:

• The benefit of an intrafamily loan is that you can get a lower interest rate than what’s currently available for a 30-year fixed rate mortgage loan. And, your parents can earn more money on the interest from this loan than if their money was in a CD at their local bank.

See how it can be a pretty good financial transaction between you and your parents or between you and another family member?

Keep in mind, there are certain strict requirements you and your family must abide by so you don’t face any gift tax or income tax penalties. You should meet with a real estate attorney to draw up loan documents and set up appropriate rates, payback requirements, etc.

The interest rate your parents give you must meet the IRS’s applicable federal rate (AFR) for an “arms-length” transaction. It must be higher than the current AFR when you initiate your loan.

So if you don’t qualify for the best rate from a bank, then maybe a family member could agree to lend you money at a lower rate to cover some of your mortgage or all of it. Plus, this loan won’t have fees, points, or mortgage insurance that can increase costs for you.

And since this loan is considered a mortgage, you’ll still get to claim a mortgage rate deduction on your taxes. Another win for you!

One of the benefits of this scenario is that your parents will earn some money from this intrafamily loan. This is especially good for those parents who can’t afford to gift money and still need money to live on. They will need to pay income taxes on this money earned, but they’d have to do that on a CD too.

Email me with any questions about having family members help with financing your home purchase. Many buyers have done this before and I can give you more guidance on family gifts and loans.

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