Four years ago, Bhima Sheridan and his wife were looking to buy a home in Berkeley. They were renters at the time, and, although Sheridan had recently quit his job working in solar engineering, they had a sizable chunk of money for a down payment. Since his wife’s income alone wasn’t enough to qualify for a mortgage in the amount they needed, Sheridan’s in-laws co-signed on the loan.
“The addition of their income was more than enough to satisfy the lender,” said Sheridan, who was able to buy a home in Berkeley’s Lorin District and is now a Realtor at Red Oak Realty. “We ended up getting a duplex. I made sure the cash flow would work.”
These days, it’s become incredibly common for parents to help their adult children buy a home. According to the California Association of Realtors’ 2016 survey of Baby Boomers in the state, 53% of parents said they intended to help their children with a down payment, and 24% said they had already done so.
Just when you thought the Bay Area housing market couldn’t get more expensive, the median sales price in the inner East Bay jumped 14%, to $782,000, in the first quarter of 2017, according to statistics from Red Oak Realty. In Berkeley, the median sales price is $1.1 million. Low inventory and fierce competition are also contributing to many prospective homebuyers — even those with means — to seek financial help from their parents.
“In the last five years, the number of times I’ve seen where parents are helping out, it’s probably anywhere from 30 to 40% of the time,” said Melissa Milton, senior mortgage advisor with Commerce Home Mortgage.
The lack of new housing construction, lower housing turnover, and high rents are also helping fuel this trend. “People in California used to move every 6 to 7 years and now it’s closer to 18,” said Leslie Appleton-Young, vice president and chief economist for the California Association of Realtors. “And the amount of turnover of the California housing stock, it ebbs and flows, but if you look back to mid- to late-’70s it was 9%, and now it’s half that.”
According to Milton, parents are typically helping by giving money — not by co-signing on a loan, which is a much more complicated process and has implications for the parents’ credit rating. Sometimes, it’s because the adult children already own a home and want to buy a new one before selling their existing home, but don’t have the cash to do so, as it’s tied up in their home equity. More often it’s first-time buyers who are getting help — but they’re not who you might think.
“There’s this common idea that it’s foreign investors or tech oligarchs who are the all-cash buyers,” said Milton. “The biggest percentage of all cash buyers is people with parents in the Boomer generation. They have access to the needed funds from a variety of sources and want to provide the down payment.”
Ironically, the fact that Boomers aren’t moving as much is making it harder on their children to find affordable homes, but it’s also giving them the opportunity to help their kids financially. “As Boomers chose to move less frequently, gains in equity present an opportunity to help their kids become homeowners,” said Appleton-Young.
The IRS currently has a gift limit of $14,000 — that’s the amount that any individual can give to someone else in a calendar year without a tax penalty. For example, a mother and father can each give $14,000 to their daughter, and if she has a partner, they can give him or her $14,000 as well.
But even $56,000 isn’t enough for a down payment on a shack in the Bay Area. And the intensely competitive nature of the local housing market, coupled with the fact that East Bay homes tend to sell for about 11% over the asking price, makes it common for buyers to get outbid repeatedly. “Parents hear this and say, ‘Oh, forget it, we’ll give you the money so you can put down the all-cash offer,’” said Milton.
Unbeknownst to many, the IRS has a lifetime gift exemption of $5.49 million per individual. That’s how some parents are able to give anywhere from $300,000 to $600,000 to their children, tax-free, according to Milton. (Note: Consult a tax professional to fully understand the implications of gifting and how to do it properly.)
Even Realtors don’t have a leg up in this market. Jeanne Lengsfelder, another agent with Red Oak Realty who lives in North Berkeley, is currently helping both her son and daughter buy homes. She’s giving her daughter — who is looking to buy in Oakland or San Francisco — a gift of funds, while she’s co-signing on the loan for her son and his wife, who are hoping to buy in Pacific Palisades. “They’re both looking in the most expensive parts of California,” said Lengsfelder.
As a cosignatory, Lengsfelder said she’s concerned that this means she’ll never be able to get another loan. Still, she didn’t hesitate to help her children when they asked for assistance. “We’re very close,” she said. “From my perspective of being in the business, I know Bay Area real estate is a solid investment, and I want my children to be able to stay here and raise their family. Helping them out financially in this situation was a win-win for us all.”
But even families who are close may want to consider all of their options when getting into financial arrangements together, said Jean Shrem, an attorney in El Cerrito who specializes in real estate law and estate planning.
In some cases, parents who are giving their children a large sum of money in the form of a loan might opt for a promissory note with a deed of trust. “That would be more of a formal situation where the parents are acting very much like lenders and their interest would be secured,” said Shrem. “That would give them the opportunity to foreclose like any lender would if the borrowers don’t meet the terms of the loan.”
The agreement can include the interest rate (usually anywhere from 2 to 6%) and length of the loan (commonly from 5 to 20 years). Typically, these types of arrangements come into play when a significant other is involved. “The parents are giving a big chunk of change and want to make sure their child’s partner doesn’t take them for a ride,” Shrem explained.
For example, one of Shrem’s clients is loaning his daughter money to buy a house with her partner, who isn’t putting much money down. “We have an agreement that says, if they break up, the daughter has the first right to buy the other half out and [the dad] gets paid back the loan if it gets sold, plus a certain percentage increase,” Shrem said. “If the partner buys the daughter out and keeps the property, then the partner has to pay the dad’s loan back first.”
Shrem recommends that parents clearly set out their expectations for the kids and to prepare for things to not work out as planned. “I always put in more terms than they’re going to think about,” she said. “Especially when it comes to parents and kids, I don’t know how good their communication is, but to make sure everyone is on the same page is really important in the beginning. You don’t want to have hurt feelings — or worse than that.”
Along those lines, Shrem says when you’re loaning a bunch of money, “treat it as any business deal.”
What’s the worst that could happen? Shrem said one couple lent their kid and their kids’ boyfriend money to buy a home, and a year later they broke up and sold the house. The boyfriend kept half the proceeds. Shrem recommends that parents keep these worst-case scenarios in mind from the beginning and come up with an agreement that has exceptions that protect the primary source of funding.
Parents who decide to co-sign should consider the implications of their decision as well. Cosigners are considered full borrowers, share ownership (and thus go on title), and are equally responsible for the mortgage — including when payments are late, which can reflect badly on their credit history. And, as Lengsfelder pointed out, it increases the overall debt-to-income ratio and can make borrowing money in the future more difficult. Parents who co-sign can be removed from the title if their child refinances — which may be important in estate planning scenarios — however, the parents are still technically on the hook for the mortgage, even if the child makes all the payments.
Even those all-cash buyers should be cautious. Milton said homebuyers who are thinking of buying a property in all cash with funds from mom and dad should check with their mortgage lender first if they’re planning on refinancing in order to immediately repay their parents, as certain specific rules apply to that kind of delayed financing. “That’s another place where people need to know, it’s not as simple as it looks,” Milton said.
How parents plan to help their children — with gift funds, a loan, or by co-signing — will determine how complex and involved the process will be. But even co-signing, which is arguably the most difficult scenario for the parents, can have its benefits.
“If anything, it brought us closer,” said Sheridan about the co-signing process with his in-laws. “It gave them a chance to feel like they’re more involved in our lives…. For them, it’s all about the grandkids.”
Tips for buying a home with help from your parents
Using gift funds:
- Tell your agent where sources of funds are coming from, as gift money has to be declared a certain way in the contract at the onset of the offer.
- Consult a qualified accountant or your lender to help you source the funds correctly (either before an escrow is opened or immediately after) and check with your accountant to make sure funds are accounted for correctly with both parties.
- Consult a qualified tax accountant for rules on gift taxes and consequences:
- Dave Herron, CPA, DZH Phillips, email@example.com
- Consider consulting an attorney who specializes in real estate law to draft up a promissory note and deed of trust as well as an agreement on how funds will be distributed at the future sale of the property
- Talk to a lender on how co-signing may affect your loans and future financing, and for details on what’s required:
- Consult with your estate planner on possible consequences of co-signing.
- Speak to a title representative on possible ways to hold title:
Agents at Red Oak Realty can help you navigate this entire process. Call or stop by our Berkeley office (1891 Solano Ave., 510-527-3387) or Oakland office (6450 Moraga Ave., 510-292-2000) or shoot us an email. We’re always happy to help.