First-time homebuyers face many challenges, but the biggest task may be coming up with a suitable down payment. Consumers in the early stages of their careers often face a fresh set of bills – and in some cases, mountains of student loan debt. A National Association of Realtors survey found that over half of recent homebuyers age 37 and younger cited student loan debt as the main down payment obstacle.
How can young Americans save up for a conventional 20% down payment, or even the 3.5% minimum down payment for FHA loans? Many have concluded that they can't – and are asking for help from their parents.
The recent annual report from the Federal Housing Administration (FHA) shows that over one-quarter (26%) of homebuyers with FHA-insured loans received some payment assistance from relatives during the 2018 fiscal year. That's an increase of over four percentage points since 2011.
How do you go about helping a son, daughter, or other relative with a down payment? Start by understanding the rules of a particular loan and lender regarding down payment gifts. Lenders can allow down payment contributions from relatives, but it's important that the process be transparent.
Recipients must clearly show that the down payment contribution is a gift with no future repayment. If a down payment contribution is in essence a short-term loan from your parents – or anyone aside from your lender – that's another outside debt obligation for lenders to factor into your qualifications.
Contact lenders well in advance to outline gift requirements. Depending on the loan type, there may be restrictions on who can provide the gift and how far in advance it must be given. (Mom and Dad can't just whip out the checkbook during closing to make a surprise contribution.)
Lenders prefer that down payment gifts be in the recipient's account three or four months before a loan application is made, although some lenders will accept shorter timeframes. You may need to plan ahead with a targeted lender and loan type well before you've started hunting for a house.
There aren't direct restrictions on the down payment gift amount, but there may be restrictions on the percentage of down payment that can be gifted.
The donor must provide a letter clearly stating that the gift is not subject to repayment. This letter must include basic information including the donor's name/address/phone number, the relationship to the recipient, the dollar amount and date of transfer, and the address of the property to be purchase with the down payment.
Homebuyers must remember that the same scrutiny will be given to any unusually large deposit (typically either 50% of the total monthly qualifying income or 1% of the adjusted purchase price of the home). Underwriters will want to make sure there are no "back-door" loans that misrepresent your debts and your long-term ability to pay back the loan. If you want to reduce your interest payments and lower your debt, join MoneyTips and use our free Debt Optimizer tool.
Parents making contributions must consider the effects on their taxes. Currently, you can make a gift of up to $15,000 per year without having to report it as taxable income. Larger contributions must be reported to the IRS using IRS Form 709. Gift taxes may apply.
First-time homebuyers are likely to face the same challenges for the near future. Increasing home prices and interest rates may make their plight even worse, especially in hotter urban markets where these homebuyers may prefer to live. Expect more Moms and Dads to come to the rescue over the next few years – if they're in an economic position to do so.
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