First-time buyers lean on the bank of mom and dad

(Reuters) - Billy Lacher couldn’t have purchased his split-level home in October without a little help from an increasingly popular financial institution: The Bank of Mom and Dad.

The 31-year-old New York City firefighter and his wife put a 10 percent downpayment on the $285,000 three-bedroom home, but his parents provided an additional $20,000 (half as gift, half as loan).

Lacher’s not unusual. About a third of first-time buyers in 2011 got either a gift (26 percent) or a loan (7 percent) from their families to help finance their home purchases, down slightly from 2010, but consistent with assistance levels seen during the last decade, according to data from the National Association of Realtors (NAR).

But industry observers think the level of parental generosity is even higher, with some giving children money for home purchases so far in advance of a loan application that the gift isn’t disclosed to lenders, or, if they’ve got the resources, buying homes outright for their adult kids and setting up an after-the-fact intra-family loan agreement.

In November, all-cash buys among first-timers hit a high of 13 percent, according to Guy Cecala of Bethesda, Maryland-based Inside Mortgage Finance, a mortgage industry newsletter publisher and researcher. That’s up from 6 percent in 2009, when IFM first began tracking it. While the company’s surveys don’t ask about the source of cash, Cecala said that when first-time buyers buy outright, it’s likely their parents who are purchasing on the children’s behalf.

What’s encouraging these all-cash purchases now? Home prices are way down - with the median price in November 2011 at just $164,200, down 3.5 percent from a year ago, according to NAR. Mortgage interest rates, too, remain at all-time lows. According to mortgage researcher HSH, the average rate on fixed 30-year loans fell steadily from 5.1 percent at the start of 2011 to 4.09 percent in December.

Many first-timers use FHA loans, requiring a 3.5 percent downpayment or 10 percent downpayment with poor credit, or VA loans, which require no downpayment, but are eligible only to military personnel.

Indeed, in some markets, without parental help, many first-time buyers wouldn’t qualify for the best rates or even a loan on the types of property for sale. To qualify for loans backed by Freddie Mac or Fannie Mae, borrowers need a 740 credit score and a hefty 20 percent downpayment — or else they’ll pay private mortgage insurance and additional “risk-based pricing” fees on their loan, IFM’s Cecala says. As the government rethinks the role of the two mortgage giants, these tighter lending standards may be here to stay, or be tightened further.

To be sure, many baby boomers want to help. More than a fifth of them have co-signed a home loan for an adult child or given a gift or loan to help them buy, according to a September survey by Better Homes & Gardens Real Estate and Research Solutions Inc. More than half of those earning at least $75,000 said they wanted to help their children finance a home purchase.

While this is all good and well, parents need to be mindful of IRS “gift tax” rules on gifts of more than $13,000, and lenders may require signed documents from the parents guaranteeing that the money is a gift, not a loan. Under IRS rules, each parent may gift up to $13,000 per year to a child, for a total of $26,000. Each parent may also gift the spouse $13,000 apiece, for another $26,000, according to Rich Arzaga, a Certified Financial Planner and CEO of Cornerstone Wealth Management in San Ramon, California.

In the case of an intra-family loan for a home buy, the borrower is supposed to disclose to the lender that they are getting a loan, and the lender will then factor the future loan repayment into the borrower’s debt-to-income ratio, impacting their borrowing limit, according to Timothy Burke, CEO of Norwood, Massachusetts-based National Family Mortgage, which helps families create and document intra-family loans.

With loans, Burke advises parents and children to work with an outside party to draw up a formal loan agreement and repayment plan, and to record the loan locally as an added lien against the property. Doing so makes the adult child accountable but also turns the interest on the intra-family loan into one that’s tax-deductible as mortgage interest.

Cornerstone’s Arzaga generally discourages parents from helping their offpsring buy on the grounds that the parents may be doing a disservice to both themselves and their kids, especially if the kids aren’t ready to manage home ownership.

From a financial perspective, he says, parents may see more benefits from gifting than loaning money. On the gift front, since it’s unclear whether the floor for which estate taxes apply may drop from $10 million now to $1 million in 2013 - Congressional decisions are still forthcoming - some parents may want to gift their children money now to reduce future estate taxes.

Loans to kids, especially if converted into real estate liens, have fewer financial perks for parents, he says.

“Loaning money to children generally isn’t meant to be a financial decision,” he says.

Because interest that parents receive on loan repayments from kids is taxed as ordinary income, parents will pay from anywhere from 5 percent to 35 percent (depending on household income) in federal taxes, as well as state taxes, Arzaga notes. Since most parents who can loan money to kids are in higher tax brackets, this means they may be looking at paying the IRS 40 percent on every dollar of interest they get from their kids’ repayments. If parents are funding the loan with money otherwise earning low interest (say, in savings) they may make more in interest even with tax impacts. But generally, Arzaga says, loaning to children carries high risks relative to other investment options.

For parents like the Lachers, the decision to help a grown child buy is about market realities, and helping a relative gain favorable financing.

“This is the time to buy,” says Theresa Lacher, Billy’s mother, noting that her in-laws, too, had loaned her and her husband money to buy back when they were 25. “But buying a home is still expensive.”


The author is a Reuters contributor. The opinions expressed are her own.

(Editing by Beth Pinsker Gladstone); +1 646 223 7289