Cori Carl found it difficult to get a home loan from a bank in 2011, partly because she worked as a freelance marketing consultant and New Hampshire installment loans banks weren’t too generous with loans to freelancers, who typically have an unsteady income.
Carl, then 26, was ready to buy a co-op apartment in Brooklyn, and thought she was in a good position to qualify for a mortgage from a bank. She had a large down payment, great credit, a steady income and long-term clients, she says. She was still turned down.
With a $60,000 down payment in hand for a $235,000 apartment she wanted to buy, Carl turned to her mother for a $175,000 private mortgage with her mom acting as the bank. Her mom had the money sitting in her checking account from a land sale she recently completed, and agreed to the loan at the then-market interest rate of 3.75 percent for 25 years in a fixed-rate loan.
“I feel better paying my mom interest, rather than a bank, and it seemed unlikely that she would foreclose on me,” she says.
From full loans from parents to down payment assistance that’s documented as gifts, there are ways for parents to help their children buy a home if they can’t get a loan from a bank or need some extra money for a down payment. All have their own rules and legal ramifications, along with tax implications, that can make wading through them difficult.
And many people do need the assistance from mom and dad. A survey by mortgage services firm Digital Risk found that 46 percent of first-time homebuyers in the last 12 months received help with a down payment from family.
Technically a gift to mom
Carl has since sold her apartment for a good profit, repaid the loan and bought a condo in cash in Toronto. But the “loan” from her mother wasn’t technically a mortgage, Carl says, because it would have required all kinds of extra paperwork.
They hired a real estate attorney to help them with some of the legal paperwork, but they put together most of the contract themselves and reported the transaction to the state.
The interest from the loan that Carl paid her mother was technically a gift to her mom, so Carl couldn’t deduct the mortgage interest from her taxes.
The Internal Revenue Service allow home loans from parents, provided they charge an interest rate for a set term that is at least the rate the IRS sets. The IRS sets rates monthly for loans with various compounding periods.
Even though Carl’s loan wasn’t technically a loan, it did follow loan procedures required for a home loan. The loan was secured against the property and a note was prepared with the terms of the loan, such as the interest rate. If Carl defaulted, her mom would legally own the property.
Giving the gift of cash
Cash gifts for a down payment on a home are just that – gifts – and the gift isn’t counted by a bank as an obligation for the person buying a home. In some cases, the entire down payment and closing costs can be 100 percent gifted by a family member, says Ken Maes of Skyline Home Loans.
And a gift for a home loan doesn’t have to only be from parents. “Many newlyweds are opting for a ‘bridal account,’ like a registry, and all the funds deposited are being used as funds to help close their loan as well,” Maes says.
Conventional loans have restrictions on financial gifts that vary on the borrower’s down payment percentage, says Jeff Taylor, a managing partner at Digital Risk. If a down payment is less than 20 percent, Freddie Mac requires at least 5 percent to be the borrower’s own money. Fannie Mae eased its rules last year and under some circumstances eligible borrower can have their entire down payment come from gifts, Taylor says.
Lenders require extensive paperwork in order to track the origin of all money used toward a home purchase, and gifts are no exception, Taylor says. All gift funds require a gift letter documenting the amount of the gift and stating that the money doesn’t have to be repaid, Taylor says, along with proof of when the funds were transferred.
Also, the window for tracking gift money deposited into a recipient’s account is usually 90 days, Taylor says. Money given earlier than 90 days before a closing is considered “seasoned” and doesn’t need to be documented, he says. Any money deposited within 90 days of a mortgage application require a paper trial.
Gift funds for a loan can’t come from the home seller, real estate agent or anyone who is a party to the sale.
Providing collateral for the loan
Without being a co-signer on a home loan, parents can help by pledging their assets as collateral, says Tom Anderson, author of “The Value of Debt in Retirement,” where he explains how the pledge works.
In Anderson’s example, someone wants to purchase a $300,000 home and needs about a 20 percent down payment of $60,000. The parents can pledge about $120,000 of assets to cover the down payment. Their child, the borrower, is then on the hook for the full loan of $300,000, but they’re not required to pay private mortgage insurance, or PMI, which is needed when a borrower doesn’t have 20 percent equity in the home.
Unlike co-signing, if the child defaults on their payments, the parent is only on the hook for the $60,000 portion they covered, Anderson says.