The American dream of homeownership is quickly moving out of reach for many, with 22% of millennials surveyed by rental listings site Apartment List saying that they expect to rent forever. For those who do hope to buy a home, 63% reported having no funds for a down payment.
If you’re looking for ways to help your kids purchase their first home, leveraging the equity that you have in your home through a home equity loan may be a way to do it.
- Make sure that you can pay back a home equity loan before risking your home for the sake of helping your kids buy one.
- With home equity loan proceeds, you can give them cash for a down payment or help pay down their debt and help them get approved for a loan.
- Keep gift taxes in mind when gifting your loan proceeds to your children.
Use a Home Equity Loan to Help Kids Buy a Home
Before taking out a home equity loan to help your kids buy their first home, consider the rest of the assets that you may have available. If you have other assets such as investment properties, cash savings, or retirement accounts, sit down with a financial planner to see which is the best to pull from for this purpose.
You may find that selling an investment property or allowing your kids to live there for reduced or zero rent may be a better option than taking out a home equity loan, especially under economic conditions with high-interest rates. A home equity loan requires a minimum of 10% equity in your home, good credit, and proof of income sufficient to pay back the loan.
Once you are approved for the loan, the cash is yours to do as you see fit. Keep in mind that you’ll be making fixed monthly payments, including interest on the amount borrowed for the length of the loan. If you’re 10 years from retirement, make sure that you can still afford to make loan payments after your retirement, or get a home equity loan with a shorter loan term.
Cash for a Down Payment
Giving your kids cash for a down payment may be the easiest way to help them buy a home, but it may not be enough. Gift taxes limit your cash after the first $16,000 per recipient per year in 2022 and $17,000 for 2023.
If you and your spouse each give $17,000 to your child in 2023 for a total of $34,000, that can provide them with a 20% down payment on a home of up to $170,000. That may sound sufficient, but in 2022, the nationwide median home price was $428,700.
Married Couples and Gifting
Even if you file a joint tax return, each spouse can gift up to the gift tax limit. This means that you and your spouse can each gift $17,000 to your child, a total of $34,000 in 2023.
If your kids are only putting 3.5% down through a Federal Housing Administration (FHA) loan, they could potentially purchase a house worth approximately $971,000 with a $34,000 down payment.
However, FHA loans carry additional costs, most notably the large up-front and annual mortgage insurance premiums that stay on for the life of the loan. In hot real estate markets, some home sellers are hesitant about accepting FHA offers if a non-FHA offer is available, as FHA loans have stringent appraisal and inspection requirements.
Help Paying Down Debt
One of the factors preventing your children from buying a home may be their debt-to-income (DTI) ratio. Student loan debt reached a record $1.745 trillion in 2022. If your kids have large student loan payments, it may be hard for them to get approved for a mortgage. Most lenders prefer a DTI of 36% or less, which can be difficult for recent graduates to attain with current college costs and entry-level salaries.
If you help your kids pay off their student loans with the proceeds from a home equity loan, you can help them get approved for a mortgage. However, keep in mind that gift tax rules may still apply.
What are the risks of a home equity loan?
There are two main risks with a home equity loan:
- That you could default on your loan and lose your home if you can’t afford to pay it back
- That you could become underwater on your loans if your home’s value decreases, making you unable to sell your home without a significant financial loss.
Can I co-sign my child’s mortgage?
Yes, you can co-sign your adult child’s mortgage, which can help them get approved for a loan if their income or credit score is insufficient or if they have too much debt. Keep in mind that you’re on the hook for the mortgage if something happens and your child becomes unable to pay it back. Co-signing will also affect your debt-to-income (DTI) ratio, which can affect your future ability to be approved for things like a mortgage or an auto loan.
Who pays gift taxes?
Generally, the giver pays the gift tax to the Internal Revenue Service (IRS), but there are some circumstances where the receiver can make arrangements to pay the gift tax. Check with a tax professional to see what is possible and the best for your situation.
The Bottom Line
If you’re willing to take on more debt to help your kids achieve homeownership, taking out a home equity loan may be a way to do it. You can use your home equity loan proceeds any way you like, but helping with a down payment or helping them to pay down debt that may be affecting their mortgage approval is the most effective way to help them buy their first home.