Question: My parents are retired. They have some money in their IRA account and have offered to help me purchase a condominium unit. The price is approximately $300,000. I am a first-time home buyer and would like to know how this works? I have a decent income but just cannot afford the price. I am concerned that if I wait too long, the price will even be higher.
Answer: There are several ways that your parents can assist you. However, before you all start down this path, make sure they consult their own financial advisors and their own attorney. They want to be assured that there will be no adverse impact on their tax situation or on their estate plan. They also must be satisfied that they will have enough money each month for themselves, should they decide to financially assist you. Also, your parents should confirm that they have the right to use their IRA funds to assist you with your real estate purchase. Some pension plans have restrictions on the use of pension funds.
Also, if you have brothers or sisters, discuss any plan with them before it is implemented. You do not want to create a sibling rivalry situation. Put yourself in the shoes of your sibling; how would you react if your parents assisted your brother or sister?
Once these formalities have been resolved, here are some suggestions. I will assume that your parents currently have $300,000 in disposable liquid assets:
Direct Loan: Your purchase price is $300,000. Your parents can lend you the entire purchase price, and you will take title to your condominium in your name only. You will sign a promissory note, agreeing to repay this money over an agreed upon period of time. To secure payment of this note (and to allow you to deduct the mortgage interest for tax purposes) you must also have a deed of trust (the mortgage document) recorded against your property in favor of your parents.
The terms of the note and deed of trust could parallel what you can get from a commercial lender. For example, you can agree to repay the loan from your parents in equal monthly installments, based on a fixed rate of 6 percent per annum, amortized over 30 years. This would give your parents a monthly income of $1798.68 — although the interest portion they receive is taxable income to them. The IRS allows family members to offer a lower interest rate than would be available commercially, but you must confirm this rate with your tax advisors.
Under this approach, you get a mortgage without the hassles — or the expenses — of a commercial lender and your parents will get a decent rate of return on their investment. If they want, your parents can gift you up to $11,000 per parent on a yearly basis; in other words, this year your parents can forgive $22,000 of the loan balance, and continue the process on a yearly basis.
Partial Loan: In the example above, your parents will lend you the entire sales proceeds. However, should they not want to provide the full $300,000, they can lend you a portion of the purchase price and the balance you will get from a commercial lender. For example, instead of borrowing $240,000 (i.e. 80 percent of the purchase price) from a commercial lender, you obtain a loan from the lender in the amount of $150,000. The difference of $150,000, would be lent by your parents, under the same terms and conditions as described above.
Here, however, there is a potential risk for your parents. Their loan would be secured as a second deed of trust. Should you go into default on the first mortgage, there is the possibility that your parents could lose their investment if the property is foreclosed upon by the first lender. Typically, a foreclosure by a first trust lender wipes out any subordinate mortgage liens.
Shared Ownership: Instead of lending you the money, your parents can purchase the property with you. They can still put up all or part of the purchase price, and title will be in all three names. There are numerous ways that title can be held. Generally speaking, title can be held 90 percent in your name and 10 percent in your parents name (or vice versa); title can be held 50-50, as joint tenants with right of survivors. Or — if your parents want their portion of the condominium to go into their estate on their death (rather than to you) — title can be held as tenants in common. This is complex and your financial advisors and attorneys will have to assist you on this matter.
There are tax benefits available to both you and your parents under a shared ownership arrangement. It is important to remember, however, that you must enter into a written agreement with your parents spelling out ownership rights and responsibilities. This agreement should be completed before you go to settlement.
Your Parents Make The Purchase: Another possible scenario is for your parents to purchase the property in their name and lease it to you. You would, of course, not get any tax benefits under this approach. Your parents could, on a yearly basis, gift you up to $11,000 for each parent, and this gift could be a percent of the title ownership. For example, a $22,000 gift the first year would equate to approximately 7.3 percent of the purchase price ($22,000 divided by $300,000). Your parents could give you a deed to this percent of the property this year, and a similar percentage on a yearly basis until you will own the entire property.
Until you own the condominium in your own name, you will have to pay rent (based on the percentage of the property owned by your parents, and your parents would get the benefits of most of the tax deductions.
There are numerous creative ways in which your parents can assist you. Sit down with them and discuss all options, and — even though they are your parents — prepare and sign a written agreement memorializing the terms you have agreed upon. This documentation may be beneficial to you in future years.
Written by Benny L. Kass