Starting out adult life can be tough, especially when a young person with a fledgling credit history tries to purchase a first home. Lenders are understandably reluctant to invest large sums of money with people who have yet to demonstrate they take their financial obligations seriously.
Having a relative or friend co-sign the mortgage could make all the difference. A co-signer could also help the borrower qualify for a larger loan and/or lower interest rate than their own income and credit profile would allow.
Lenders want to see co-signers with a good credit history and enough income to repay the loan should the borrower default. As a co-signer, you are guaranteeing the loan, bearing as much responsibility for it as the borrower. If the borrower fails to make payments, you’ll have to make them or risk damaging your own credit. In some states, lenders can even collect the debt from the co-signer(s) without first trying to collect it from the borrower.
Remember, too, information about the loan will show up on your credit report – even if payments are made on time — affecting how much you can borrow for a home or other loan. A co-signer’s name will not be removed from the loan until it is paid in full or the borrower qualifies for the loan without your help. You can limit your risk in the transaction if:
- The primary borrower has enough income to support the payments and has proven to be responsible about meeting financial obligations even though he or she has not yet had time to build a credit record.
- You have enough income in a pinch to make payments or pay off the loan without damaging your ability to borrow.
- The lender agrees to notify you, in writing, if the borrower misses a payment. This would give you time to step in, making payments without having to repay the loan in full.
- You receive copies of all paperwork associated with the loan, including the contract, the Truth-in-Lending Disclosure Statement, and warranties.
- Your relationship with the borrower is open and trusting, including good, frequent communication about financial dealings.
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Equity Sharing
In addition to co-signing a loan, relatives can help a family member buy a home by contributing to the home’s down payment, monthly payments and/or maintenance costs in exchange for a share of the home’s equity (profits) when it is sold. Be sure to draw up a detailed legal agreement making it clear how much each investor will receive at sale time and what their position — and financial obligation — would be should the primary borrower default or forfeit the home. |
Helping First-Time Home Buyers
Even though they have enough income and great credit to buy a home, many first-time would-be home buyers run into a roadblock when it comes to having enough cash for a down payment and closing costs. That’s an opportunity for parents — or other family members or friends — to help by making a cash gift to the buyers.
If you’re ready to help a loved one with a gift to purchase a home, be aware of the tax-rule limits for 2013. The IRS says a taxpayer (you) personally can give up to $14,000 per year to anyone (your child), with no tax ramifications.
If you are married, your spouse can also give $14,000 to that same child. In addition, if your child is married, you and your spouse can each give $14,000 to your child’s spouse with no tax ramifications. (Of course, the in-laws could do the same thing.)
The bottom line: Two parents can give a married couple up to $56,000 per year without tax consequences. Those four gifts would equal a 20% down payment on a $280,000 property. If other relatives want to kick in, even better!
Any amount you give above the $14,000 per-person annual limit will be deducted from your lifetime tax-free gift limit — currently $1 million. For more information, see IRS Publication 950 “Introduction To Estate And Gift Taxes.”
As for the home buyer receiving the gift, his or her lender will ask for a gift letter signed by the giver, verifying that the amount is, in fact, a gift — not a loan that must be repaid. (Note: Recipients are never required to declare gifts as income, nor pay taxes on them.)
Buyers should note, too, that different loan programs have different policies on the use of gift funds for down payments. We would be happy to answer any questions you or your loved ones have about down-payment requirements.
PASSING IT ON
Planning To Bequeath Your Home
Leaving your home to an heir in your Will may not be the best way to transfer it to the next generation. To minimize estate taxes, you may want to consider using a “By-Pass Trust” or a “Qualified Personal Residence Trust,” arrangements that must be made prior to your death.
Contact your personal financial planner or your attorney to find out if these trusts could better protect your heirs’ financial interests.
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