Buying a first home is often considered a rite of passage for young adults. But as housing prices skyrocketed over the past decade—followed more recently by rising mortgage rates—first-time buyers have had difficulty breaking into the market.
Giving your child a leg up for a first-time purchase or helping them upgrade to a larger home as their family grows can offer multiple benefits, says Tamara Costa, vice president, advanced planning at Fidelity. “It can accomplish several objectives, including wealth transfer for estate tax savings purposes in a manner that could have significant financial impact for the child, along with instilling a sense of responsibility,” Costa explains. But it's important to consider your own financial plans, the risk of incurring unnecessary taxes, and if you have multiple children, fairness and family dynamics. Below, Costa outlines potential benefits and considerations of 4 common approaches.
1. Gift your child a down payment
Especially for younger buyers, coming up with a down payment may be the biggest hurdle to buying a home. But even if your child has savings of their own, there are reasons to consider helping out. In a competitive housing market, having a bigger down payment can make them more attractive as buyers. A larger down payment also might help your child qualify for a lower mortgage rate.
The biggest issue to watch for is the gift tax. You can give any person up to $17,000 a year in 2023 without triggering gift taxes, and if both parents make an individual gift, that total can be as much as $34,000 per child. If you go over your annual gift tax exclusion, “you don’t write a check to the IRS,” explains Costa. Rather, the excess reduces your lifetime gift exemption, which is $12.92 million per person (or $25.84 million for a couple) for 2023.
2. Make a family loan
If you’re concerned about your child being financially responsible, loaning them the money will ensure that they have skin in the game. A loan, after all, is not a gift, and it shouldn’t count as one for tax purposes. Another benefit of a loan is that you can charge a lower interest rate than your child is likely to get through a traditional lender—an added bonus in today’s rising-rate environment.
You will have to follow IRS guidelines for intrafamily loans so that the agency doesn’t consider it a gift. That includes charging the IRS minimum rate, which is updated monthly. In May 2023, for instance, the annual interest rate for a long-term intrafamily loan of 9 or more years was 3.72%. "The IRS requires this loan to be an arm’s-length transaction, meaning you loan the money to the child in exchange for a promissory note outlining the terms, like how long it will take to repay,” says Costa. (Read “Tapping into the family bank“ for more detail on loan structures and rules).
Keep in mind that the interest payments will be taxable income, which could potentially bump you into a higher tax bracket. Your child, however, may be able to deduct the interest they’ve paid you when they file their taxes. “This is a complex transaction, with a lot of nuances,” says Costa, so consider consulting with a financial professional or attorney.
3. Become your child’s landlord
Another option is to buy the house yourself and let your child live in it and pay you rent, a strategy that can also help your child build good financial habits. Later, once your child is more financially secure, you could offer to sell them the house. Or, when and if your child moves out, you have flexibility: you can sell the house, rent it out, or use it as a vacation home.
If you’re concerned that a gift of a down payment or a low-interest loan wouldn’t be fair to your other children, buying the house and charging a fair rent might diffuse any potential family disputes.
As with a loan, the child needs to uphold their end of the bargain. “If they’re living rent-free, the IRS might see this as a gift,” Costa says. Similarly, if you do decide to sell your child the home later, the price must be the fair market value. Otherwise, the IRS could consider the difference between the fair market value and the sale price a gift, which would be counted against your lifetime gift tax exemption. In addition to making sure your child knows they must pay rent on time, set clear expectations for the upkeep of the property. Since the home is yours, it could cause friction if the child doesn’t take care of it.
4. Co-sign the mortgage with your child
A fourth option is to co-sign your child’s mortgage. Because the lender will consider your credit history as well as your child’s, your child may have an easier time qualifying—or qualify for a larger mortgage than they could have gotten on their own. “The child would still be the owner of the home,” Costa says, “but the co-signer guarantees the loan in the case of default.”
This route gives your child the most independence, plus a chance to build a good credit score by paying their mortgage on time each month. If the child defaults, however, your credit is on the line too. Parents are sometimes unaware that their child isn’t making payments, Costa says. “That can get tricky—if the child loses their job or can’t make payments, parents will have to if they want the child to stay in the house. Parents need to be aware of these risks.” Consider setting out clear ground rules before co-signing, including possibly asking your child for proof that they’re making their payments on time.
Helping your child buy a home can be more than providing them with a place to live—it can also set them on the path to building long-term wealth. “Owning a home can be a way to launch your child into a financially secure adulthood,” says Costa. Consult with a tax attorney or financial professional to help you determine what each approach could mean for your personal financial situation.