The Bank of Mom and Dad: Helping Your Kids Buy a Home Without Breaking the Bank

Buying a first home isn’t what it used to be.

Between high home prices and mortgage rates hovering around 7%, many young adults are finding it difficult to afford a home. Even those with good jobs and steady incomes are struggling to make the numbers work.

And that’s where the Bank of Mom and Dad comes in.

More parents and grandparents are looking for ways to help their children buy a home. Some are giving money for a down payment. Others are making loans directly to their children, sometimes at interest rates much lower than a bank would charge.

What many families don’t realize is that helping your children buy a home can also be a smart estate planning strategy.

Done properly, it may save your children thousands of dollars in interest, reduce future estate taxes, and allow you to enjoy seeing your children benefit from your generosity while you’re still around.

But there are a few things you need to understand before opening the family bank.

Why This Matters

Let’s say your daughter wants to buy a $300,000 home.

She needs to borrow $240,000. At a 7% mortgage rate, her monthly principal and interest payment on a 30-year loan would be about $1,597.

But suppose you have enough savings to lend her the money instead.

The IRS allows family members to make loans at special minimum interest rates, called the Applicable Federal Rate (AFR).

These rates are published monthly by the IRS and are often lower than traditional mortgage rates.

For example, let’s assume you could make the same 30-year loan at 4.5%.

Here’s the difference:

That’s about $381 less each month and more than $137,000 in interest savings over the life of the loan.

And instead of paying interest to a bank, your daughter would be paying it to you.

Of course, these are illustrative rates, not a quote of the current IRS rate. The actual minimum rate depends on when the loan is made and how it is structured.

There’s an Estate Planning Benefit, Too

Here’s where things get interesting.

Suppose you have a sizable estate and were already planning to leave money to your children someday.

Instead of waiting until you die, you could help them now.

You might make a loan to your child and later decide to forgive part of the balance as a gift.

Under federal gift tax rules, you can generally give a certain amount to each person every year without using any of your lifetime gift and estate tax exemption.

That means you may be able to gradually reduce what your child owes while also reducing the value of your estate.

And your child gets to enjoy the benefit now, when buying a home may make the biggest difference in their life.

However, there’s an important distinction.

A loan is not the same as a gift.

If you intend to make a loan, it needs to be a real loan, with a repayment obligation, a proper interest rate, and a payment schedule.

You should not make a loan with a secret understanding that it will automatically be forgiven later. That can create tax problems.

Instead, you can make separate decisions about gifts in future years.

Also, interest you receive is generally taxable income to you. Your child may qualify for a mortgage interest deduction if the loan meets the applicable tax rules, but that deduction is not automatic.

What Could Go Wrong?

I’ve seen enough family situations over the years to know that money and family relationships don’t always mix as smoothly as we’d like.

What happens if your child gets divorced?

What if they stop making payments?

What if you need the money back to pay for your own long-term care?

What if you have three children, but only one receives financial help?

And what happens to the unpaid loan if you die?

These aren’t reasons to avoid helping your children. They’re reasons to plan carefully.

For Michigan families, a properly structured family mortgage can provide security for the parents while giving the child a more affordable way to own a home.

The arrangement should also fit into your estate plan.

For example, you might want the remaining loan balance forgiven when you die. Or you might want it deducted from that child’s inheritance so your children are treated fairly.

And if Medicaid planning could become an issue, gifts and forgiven loans require special care. Giving away assets can affect eligibility for long-term care benefits.

One more important point: If your child is also getting a traditional mortgage, the bank needs to know whether money from you is a gift or a loan. An undisclosed family loan can create serious problems with the mortgage approval.

Simple Lesson

Helping your children while you’re alive can be just as meaningful as leaving them an inheritance.

Sometimes more meaningful.

But generosity works best when it is paired with a plan that protects both generations.

Action Step

If you’re thinking about helping a child or grandchild buy a home, consider whether a gift, a family loan, or some combination makes the most sense.

Before transferring money, review how the arrangement might affect your retirement security, taxes, long-term care planning, and estate plan.

The goal is simple: Help your children get ahead without putting your own future at risk.

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If this topic raises questions for you or your family, feel free to call (517) 548-7400 or contact us online: https://www.michiganestateplans.com/contact-us