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Some rules for helping your kid buy a house

In some circles, the graduation gift du jour is a Manhattan apartment, according to a recent New York Times story. Note to my kids: Sorry, we are not in those circles.
/ Source: Reuters

In some circles, the graduation gift du jour is a Manhattan apartment, according to a recent New York Times story. Note to my kids: Sorry, we are not in those circles.

Still, it would be nice. Given current market conditions, a compelling argument could be made for helping your kids buy their first home.

"Now is the time," says Benjamin Tobias, a Plantation, Florida, financial adviser who helped his 29-year-old son and daughter-in-law purchase a home. "We feel that in this area, we are at or very close to the bottom of the housing market, and with low interest rates on top of that, anybody who can should be buying now," he said.

In addition to the opportunities some see in the real estate market is the financial disparity between the generations. Baby boomers have money to invest, but are turned off by the low interest rates offered on bank savings and the risks posed by stocks and bonds. Many have children coming out of college unable to find the kinds of jobs that would allow them to save up the big down payments many lenders now require. Others are trying to erase past credit problems (or short sales of homes they previously owned) and can't get mortgages in today's more careful lending market.

"We get asked this question (helping kids buy a house) so often," said Mark Rylance, a Newport Beach, California, financial adviser. But he's seen good intentions backfire on all concerned, so he warns clients about the downside. Buy a house for a deadbeat kid — or even at the wrong time for a solid bill-paying one — and a bad turn in the housing or job market can ruin your credit score, your bank account and your relationship.

If you can afford to help (the most important consideration) and you want to, make sure you set it up in the most advantageous way. There are a variety of financial arrangements that can accomplish this: Parents can lend a down payment (or the entire mortgage) to the child; they can co-sign a bank loan, enter into a shared-equity arrangement with the younger generation or simply hand their kids a sum of money as a gift. They can also buy a house themselves and work out a rent-to-buy arrangement with their children.

Here are some considerations:

Apply due diligence to the dealHave the house appraised and get the best advice you can about the real estate market in the area where the kids are house shopping. Parents who helped their kids buy a house at the height of the housing market are suffering along with them now.

Rylance has a client who loaned his son $100,000 for a down payment on a $500,000 house, but then life intervened. As real estate values plummeted in Orange County, his son's family grew. Now the house is too small, but the son can't move his family because he is seriously under water on the loan — to his father! That would make strategic default pretty messy.

Nail down the legal details
These financial arrangements can maximize tax breaks if they are structured correctly. Get a financial professional to review your arrangement, and perhaps a lawyer to commit it to paper.

Give them a down paymentAnyone can give anyone else $13,000 a year without running into gift tax problems. So a couple can give a couple as much as $52,000.

Make a private mortgage Well-heeled parents can skip the middle-man banker and make the whole loan; an approach that often benefits the parent and the child. If it's a long-term loan, the interest rate has to be over 3.82 percent (the Internal Revenue Service adjusts that rate regularly) to make the deal qualify as a loan and not a gift. But that still offers the parents more income than they'd get at the bank and gives the child a low rate and, as the loan is secured by the house, a mortgage interest deduction. A relatively new company, National Family Mortgage, will, for a fee, structure the mortgage and even service it for you, so the child sends her monthly payment to a third party.

This approach has advantages for wealthy parents who want to get money out of the estate. By "lending" the child money and then giving them a separate amount every year (those gift tax limits would apply), they can get money out of their estates.

The disadvantage to this approach is that the mortgage won't help the child's credit history. And the child should have some skin in the game, so make sure there's a down payment that you aren't providing.

Share equityBert Whitehead, a fee-only financial adviser in Franklin, Michigan, is very big on these arrangements. When a client wants to help the next generation buy a house, the client puts up the 20 percent down payment, and the kid makes the payments. After five years (or other agreed-upon period), the home is sold, and the parent and child split the profits. That worked well, years ago, when Whitehead did it with his son. But clients who did this at the peak of the housing boom now find they are sharing debts instead of equities.

Co-sign their loan
That could be all the kids need to get a good mortgage, and that's what Tobias did for his son — who couldn't get a mortgage because he'd been on a two-year adventure travel spree. But Tobias' son now works with him (and the son's wife has a good job), so he's confident he'll be paid back. The problem with the co-signing approach is that you're on the hook if your child fails to keep up payments. If he's even late, it can impact your credit score. And if you want to buy another home yourself, you may find the co-signed loan uses up your borrowing bandwidth.

Buy a home and rent it to your kidsThat may be a good investment for you, but it doesn't really do much for your kids, points out Brian Kazanchy, a Morristown, New Jersey, wealth manager. "It doesn't give them any ownership or upside, and it may also prevent them from building responsibility," he said.

Do the deal and then stand back
Helping your kids buy a house can be a blessing for all concerned. But being that parent who helps the kids and then spends the next 20 years picking paint colors, moving furniture and walking in at will? Not so much.