I often see a down payment gift on a home turning into a never-ending series of gifts. This can become a financial and personal strain on both parties in the relationship. I recommend a strategy that would help avoid getting into such a situation.
The Need For Due Diligence By Both Parties
Both parties need to make sure that they are financially prepared to give or receive the gift. To help determine this, you need to answer the following three questions:
1. Can You Afford To Give A Down Payment Gift?
Here are some questions that can help determine if you can afford to give the gift. Is your mortgage paid off? Do you have zero credit card debt? Are you maxing out your retirement contributions, including the catch-up provisions? Have you discussed with other family members about giving the gift? Are you prepared to gift other family members the same amount, too? Is the gift a small percentage of your net worth? Are you mortgaging your future for the benefit of another’s future?
2. Is The Receiver Of The Gift Ready To Own A Home?
Homeownership requires both personal responsibility and financial responsibility. So, before gifting money for a home down payment make sure the receiver can pay for the mortgage and the home repairs. A few questions will help you determine their financial discipline. Do they have any credit card debt? Are they putting at least 6% of their pay in a retirement plan? Are they also putting money towards the down payment? Do they have significant student debt or other debt? If you don’t like the answers you get, then they will most likely run into financial trouble as homeowners.
3. Whose Dream Is It To Be A Homeowner?
I often find that the goal of homeownership is more of the parent’s dream than the child’s dream. The parents likely benefited from homeownership by sale price increases and tax benefits. Additionally, parents may also see paying rent as a waste of money. So, make sure the dream of homeownership is the child’s dream and not the parent’s dream.
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Be Aware Of The Annual Gift Tax Exclusions
The giver of the gift pays the gift taxes, not the receiver. The 2024 annual gift exclusion is $18,000 per person in a calendar year. Two parents can gift one child $18,000 each for a total of $36,000 with no gift tax consequences. For married children, the parents can gift $36,000 to the spouse for a total of $72,000 in a calendar year. You can double these amounts with proper timing. Let’s assume a child needs $60,000 for a down payment in February. To meet this amount, the parents could gift the child $30,000 in December and $30,000 in January of the next year. Make sure the gift deposits are visible on the bank statements to show the trail of the gifts to the lender.
For more information on gift taxes see this article from the IRS
Gift Letter Required By The Mortage Lender
Mortgage lenders want to make sure the borrower has the ability to pay back the loan. Thus, mortgage lenders will ask to see bank statements to show the source of the downpayment. Large onetime deposits can set off red flags. If the down payment is from a gift, the lender will need the borrower to provide a gift letter. The letter assures them the gift is not a loan and the gift-giver has no financial interest in the property.
For more information on gift letters, see this unsponsored article from Rocket Mortgage
Consider Using A Matching Savings Plan
The best method of assisting a child to buy a home is by matching their savings for a home. Let’s assume the child needs $60,000 for a down payment to buy a $300,000 home. Tell them that once they have saved $30,000, you will match the $30,000 to get to the $60,000 down payment. If after a year or two they have saved very little money, then they may lack the financial discipline to own a home. Gifting them money in this situation could put both parties in financial peril.
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