Our children never stop being our children, no matter how old they get. As parents we may feel compelled to help them when they need it.
One area parents often try to help is with a home purchase. Unfortunately, this isn’t done strategically or with the consultation of a wealth advisor. They often give their kids a check or buy it outright, which may lead to tax or liquidity problems later.
“People need to feel comfortable with having a discussion about borrowing and most people don’t,” said Joe Gonzalez, CEO of Lending Strategy Advisers. “I don’t care how much wealth you have, it’s a very uncomfortable discussion. It goes back to the beginning of time where people feel like, if you had to borrow there was something wrong. You want to encourage borrowing. Borrowing is strategic. Borrowing is how the world works.”
Borrowing While Having Millions
Borrowing to buy a home for an adult child seems counterintuitive when you have $5 million of liquidity sitting in an account. If your child has no job or proof of income, how do they qualify for a loan of that size? Phantom income, according to Gonzalez.
Every lender has different rules but $5 million can create a situation called “asset dissipation.” A borrower uses the value of that asset to represent an income stream to secure a loan. It’s a better option than liquidating $1 million.
“I have met way too many clients that have bought something outright and then they can’t make the tax payment on that money, or they can’t make other payments because they put all that liquidity into the house,” Gonzalez said. “It’s extremely difficult to get that liquidity back.”
Is It a Gift?
Sometimes the hurdle isn’t qualifying for the loan but making the down payment. Parents want to help, but they don’t want their children to be subject to taxes on a gift, and they don’t want their kids to have a loan of that size on their balance sheet. It shouldn’t be an issue according to Gonzalez.
“Gifting in the world of borrowing isn’t a reportable event,” he said. “If you gift your kids $50,000 to buy a home, the bank makes you sign a gift letter that basically says, ‘I swear this is a gift and not a loan.’”
Gonzalez said the letter stays with the lender. It doesn’t go to the IRS. The children can pay it back if they want, but they don’t have to. It takes the fear out of gifting, he said.
No More Co-signing
Gonzalez explained those days are over. Parents can no longer just co-sign as simple guarantors. They are adding their liquidity to their children in these transactions.
If the children can document that they intend to occupy the property as their primary residence, they can get financing for themselves, and still use the parents as co-borrowers he said. But the parents need to understand that their credit is being pulled, and their resources are being counted on as far as income and sometimes potentially assets.
“So, kids can co-borrow with parents or parents can co-borrow, but there’s no such thing as just, co-signing, without providing any documentation,” Gonzalez said. “The parents enter into an application process, and it can get really complicated.”
Assisting a child with a home purchase may be an opportunity to help provide a nest egg for that child. It’s important to speak with a financial advisor to understand the best way to protect liquidity and not suffer the consequences of a hefty tax bill in the process.