Waxing serious, as a real estate broker, I’d like to share with you some advice that may save your family, your retirement, and your sanity. I’m talking about giving your kids the down payment on a house.
Prescience is a perk we Realtors acquire after years of watching others make life-altering decisions—the omniscient perspective we get from our rearview mirrors. We just know how some things will turn out—like giving kids the down payment for a house.
One day while walking my neighborhood, I ran into a rather feeble-looking octogenarian trying to cut his lawn with a push mower.
“I’d sure love to move to a retirement place and give up all this yard work,” he said.
“Well, I bet you can,” I answered. “You’re an original owner; your mortgage was probably paid off years ago. What’s stopping you?” He laughed.
“I refi’d to give each of the kids a down payment on their homes.” The kids who couldn’t help Dad with the yard work.
Why do otherwise intelligent and caring human beings, who make their children brush their teeth so they don’t fall out, look both ways before crossing the street, and send them to college, lovingly set them up for failure by effectively saying, “Here, take the fruits of my labor which I (not you) toiled years to earn, with no (enforceable) strings attached, given willingly with the implicit message that the best things in life can be had for free? Go forth into the real estate market secure in the belief that someone will always rescue you?” Are we teaching them well?
Sylvia Browne, a renowned psychic, said, “You have to take care of Number One before you can help anyone else.” A psychic said that. Is the gratification of giving the kids all that money worth the risk to your own security later in life? Are you playing Russian roulette with the roof over your head? Maybe it’s a drop in your bucket, but think of the message you send. When you live within your means and don’t overextend yourself, when you’re that rock the family can come to in times of emergency (buying a house is not an emergency), you teach them to do the same. Show, don’t tell.
Some parents know the right answers when asked to pluck feathers from their nest egg. They just need a little reinforcement:
Smart Dad: “I don’t know what to do. I mean, I loaned my daughter and her husband the down payment, he quit his job, and now they’re in foreclosure and want me to bail them out.”
Me: “OK. Let me see if I understand this correctly. You gave them $50,000, and they don’t seem to be trying too hard to preserve and protect it.”
“No, I loaned it to them.”
As Len Tillem, the “People’s Lawya” in Sonoma, California, tells his radio audience: “If you make a loan to a family member, consider it a gift.” They did.
“Well, Smart Dad, I know you love your daughter dearly, but in your heart of hearts, how do you feel about her husband abusing your trust and generosity?” I knew what he was thinking, so I just verbalized it for him. He needed a few booster calls afterward, but he did the right thing, the hard thing: He said no.
Like daylight saving time rolling around every year, I could count on an annual phone call from another dad, whose daughter wanted to buy a house at least once a year. Dad was a self-made multimillionaire and could easily have bought her silence. But he wanted her to earn the satisfaction of owning a home the traditional way—by working for it. So every year he’d call me up and the three of us would drive over to this year’s pick, and I would explain to her why it would not be a good investment. I won’t admit to collusion because that’s illegal, but Dad and I thought alike. Eventually she saved enough money to buy a condo.
Raising kids is a science project; the laws of nature prevail.
If you are a parent, you may be squirming in your seat right now, about to stop reading this, thinking, “Cathy, you are cruel! You advocate child abuse. My child would never renege on a promise.” And you could be right; there are always exceptions to the rules…anomalies in nature. But here are some alternatives to save you and your offspring from possible financial and moral ruin:
First assumption: you are the parent, not a friend or other relation. Second: you have the financial means to help your kids buy a home. If not, well, think of it as a blessing in disguise that they have to work for it. Speaking from my rear view mirror, I would not take this risk for anyone but direct, blood line (or legally adopted), offspring—the ones who can guilt you out of sleep at night.
Scenario Number One: Friends with Benefits
Forget the usual innuendo: This is all about the parent-child relationship. Thinking of each other as friends (whom you can’t push as far as you can parents) puts a little distance between you. The benefits are the money you inject:
- You lend the kids the down payment (mortgage companies typically want a letter saying this is a gift, not a loan, and will either require a gift letter signed by you, or the money seasoned in the kids’ bank account for two months).
- They qualify for the loan on their own and purchase the home.
- After close of escrow, you go on title—perfectly legal.
The beauty of this approach is that the kids have to qualify for the loan—prove that they can afford to live there (thanks to your help). This minimizes your exposure; they can’t refinance (further encumber) or even sell the house without your permission because you are on title. You can hover over your down payment.
The downsides are:
- The kids could stop making payments to the bank (and/or you), and if they default, you’re on title—it will appear on your credit report, too. But you won’t be liable for repayment of the loan.
- Litigiously speaking, if anything bad happens at the property, you could be pursued. And you don’t have to be guilty to need a lawyer.
Scenario Number Two: Lease Option
The preferred choice. In simple terms, rent-to-buy. You, most benevolent parent, buy the house in your name, lease it to the kids, and let them buy it from you at a later date. Lease options have their downsides, too:
- The purchase price is agreed upon and must be honored months or years from the date, regardless of whether the market goes up or down. Good for the buyer, bad for the seller, but it’s all in the family.
- The buyer pays option consideration, usually several thousand dollars, which can be collected up front or monthly. If the option is not exercised, the buyer forfeits his down payment.
Effectively, the lease option creates a landlord/tenant relationship with all the inherent issues that go with rental property.
I don’t recommend lease options except in the parent to son or daughter situation. There are some things you do for love. It’s an expedient that can work well for families.
Why do I prefer Scenario Number Two? Think of it as having the kids audition to own property. Over a period of time they’ll prove they’re worthy of your cash infusion by making timely rent payments. They’ll establish a track record with a landlord (you), which lenders insist on. They’ll prove they’re responsible and serious by fixing whatever credit issue stopped them from qualifying before. Or not. But if they don’t become models of tenant virtue, you’ve lost little or nothing. You can sell the house to someone else, and that person can become the kids’ landlord.
If (Scenario Number One) the kids can qualify for a mortgage on their own but you’re not convinced your down payment money is safe with them, insist on a lease option until which time you feel comfortable with less control over your money or until they give you a grandchild.
Here’s how to do a lease option:
- Talk to a lender and determine what the kids would qualify for if they had a down payment or when they overcome the credit issue or whatever it is that’s preventing them from buying. Don’t fluff on this. You’ll want them to be able to buy the home from you eventually. Lease optioning is just a stopgap measure.
- Add the loan amount to the down payment which is typically 20 percent of the sale price for owner-occupied loans; that should be what you’re willing to pay for the home. Do not exceed that, no matter how much the kids beg. It’s “get real” time.
- Hire a Realtor and let the kids choose their new home.
- Visit the real estate attorney and have him or her explain structuring and all the technicalities of lease options. If you decide to proceed, go back to the attorney to draw the lease option documents. Realtors can do this, but I think it’s better to have an attorney do it.
- Buy the home. Have the attorney prepare the lease option concurrently so that everything is in place when you close escrow.
You may get some negative feedback from the kids on these suggestions. They whine, “Why can’t we buy a bigger house?” “We want the tax write-off now,” etc. Remind them that home ownership is not a right—it’s the American Dream. Then silently say to yourself, I’ve minimized my risk. Because no matter how wonderful the kids are, nothing is without risk—especially real estate.