Avoid Trouble on Your Kids' Mortgage
Many first-time home buyers are getting a financial shot-in-the-arm from their
parents. It's easy to understand why. With mortgage rates better than ever,
young people sometimes just need a boost from their parents to afford their
first home? But before they help their kids make a down payment or qualify
for a loan, parents should know the risks of playing financial benefactor,
says Lew Sichelman in The Journal Newspapers.
1 - Co-signing
Qualifying for a mortgage can be tough early-on in life if your
income isn't high enough, or you haven't yet established a credit record.
Parents can help by co-signing the note and guaranteeing the mortgage.
Remember, at least 5 percent of the down payment still must come from the
borrower's personal funds on a co-signed mortgage, so long as the down payment
is 20 percent or less which is very likely. The advantage is that the lender
may be more generous on the qualifying ratios for income and debt. The kids
could qualify with a monthly expense-to-income ratio as high as 35 percent,
and with a total debt-to-income ratio up to 43 percent. That's seven
percentage points better than normal.
Remember, parents: the next time you apply for a loan, the lender will
include any mortgage you have co-signed into YOUR debt-to-income ratio. And
guess who's responsible if the kids don't make their monthly payments?
Although lenders don't typically go after parents in a default situation, the
end result is a spot on your credit record. That's all you need to make it
more difficult to get a loan of your own. In situations where the house is
worth less than what's still owed, you could be financially liable for taxes
on the difference. In the worst-case scenario, parents may regret co-signing
for their kids after paying for their kids' blown financial obligations.
The problem is when young people default on a loan, they
frequently don't bother to tell their parents. You may not find out until you
apply for a loan and discover it on your credit record. Avoid nasty surprises
by telling the lender to notify all borrowers, including you as co-signer,
whenever a payment is late. That early warning also gives you the chance to
bail the kids out, if necessary, before things get out of hand. Another way
to reduce your long-term risk is to take your name off the note as soon as the
kids can qualify with their own assets.
2 - Down Payment Help
Parents who want to help on the down payment are allowed to make up the
difference in a gift. But lenders will want certain assurances. You'll have
to sign a letter specifying the gift amount and when the funds were
transferred, that no repayment is expected, and that you have sufficient funds
to cover the gift. Wait until settlement before transferring the
funds--they'll be easier to trace and you can collect interest in the
meantime. You may wish to consider loaning the kids money, too. Borrowed
funds can be used as part of a down payment so long as some asset secures the
funds. The lender will want to verify that the loan is secured. In any
event, make sure you lay out the terms of your loan in writing. If the kids
don't pay you back, you'll need documentation to be able to write off the loss
on your taxes.