Millennials’ New Weapon in the Bidding Wars: A Parent’s Home Equity
Call it the mortgage carousel: Parents refinance their home to finance the full cost of the home their son or daughter wants. This allows the child to compete as a desirable all-cash buyer in an area where bidding wars are common. Then, at the closing of the purchase, the child refinances the new house and reimburses the parents.
Sellers often prefer cash because deals can be closed quickly without conditioning the deal on financing. This is especially important in bidding wars: if the purchase price is higher than the list price and the appraised value, it can be difficult to get a loan, said Kas Divband, an agent from Washington, D.C., at Redfin. Mr Divband said he had worked on six deals in which the buyer relied on a relative’s mortgage to make a cash offer.
The strategy also shows how difficult it is for millennials to enter the housing market for first homes, where the competition is fiercest. Even those with well-paying jobs and big down payments are losing out, especially in cities with strong labor markets for young people, like Washington, Boston and Seattle, said Nela Richardson, chief economist at Redfin.
Redfin agent Cody Coffman recently worked with an Olympic athlete in his twenties who paid $2.8 million for his first home, a newly built five-bedroom house in the Venice neighborhood of Los Angeles, listed at $2.758 million. His parents took out a home equity line of credit, or Heloc, to give him the full purchase price, allowing him to beat four other offers.
“Getting him to talk to his parents was probably the hardest part,” Mr. Coffman said, as it wasn’t every day that their son asked for $2 million. The athlete worked with a loan agent who vetted him before the purchase and also managed his parents’ line of credit.
This move will not work for everyone. Parents need to have enough equity in their home to make a refinance worthwhile, and the same goes for the child’s new home. Both parties must be prepared to take on the added hassle and cost of two loans. And mixing family and money is often difficult.
Here are some other things to keep in mind:
• Loan options. Parents have several options for using the equity in their home, including a cash refinance, which allows borrowers to refinance an existing mortgage plus an additional amount and withdraw the difference in cash; a home equity loan, which is a loan on the value of a house, including a second mortgage; or a Heloc, which works like a credit card, allowing owners to qualify in advance and withdraw funds when the kid is ready to close.
• Finance fails. The biggest risk is that the children will not qualify for a loan, or for a loan as large as expected, especially if they pay more than the asking price or if the market cools. To avoid this outcome, let the lender know your plans ahead of time, Divband said. It may be more convenient to use a loan officer for both transactions.
Note that some lenders want buyers to live in a home for three to six months before refinancing. An alternative is a deferred finance mortgage, which allows a buyer to buy the home in cash and refinance the day after closing for up to 80% of the home’s value, said Peter Lucia, production manager at Brecksville, Ohio. Cross Country Mortgage.
• Think like a lender. Parents must do the same kind of due diligence as a lender, including checking the children’s finances. Tim Manni, mortgage expert at NerdWallet, a San Francisco-based personal finance company, recommends working with an attorney to draft a family loan agreement outlining repayment terms and other stipulations. Buyers may also want to have their home inspected.
• Consider the costs. A purchase mortgage or refinance would typically cost around 2% of the loan’s value, Lucia said. Most closing costs would apply to two loans instead of one. Fortunately, prepayment penalties are rare on primary residence loans, though they can apply to investment properties, Lucia said.
• Tax advice. Donors must report donations over $14,000 per person per year under federal tax law, although an individual must only pay taxes after exceeding the $5.49 million tax exemption. dollars on donations, which is a lifetime limit. Interest on the first $1 million of a purchase mortgage is tax deductible, compared to only the first $100,000 of a home equity loan or line of credit. Both parties should consult a tax professional.
Corrections & Amplifications
Donors must report donations over $14,000 per person per year under federal tax law, but an individual must only pay taxes after exceeding the $5.49 million tax exemption on donations, which is a lifetime limit. An earlier version of this article did not specify that an individual only owes this federal gift tax if the lifetime limit is exceeded. (October 13, 2017)
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