Using a Home Equity Loan to Help Kids Buy a First Home

The American dream of homeownership is quickly moving out of reach for many, with 18% of millennials surveyed by rental listings site Apartment List saying that they expect to rent forever. For those who do hope to buy a home, 63% reported having no money for a down payment.

If you’re looking for ways to help your kids purchase their first home, leveraging the equity that you have in your home through a home equity loan may be the best way to do it.

Key Takeaways

  • Make sure that you can pay back a home equity loan before risking your home for the sake of helping your kids buy one.
  • With home equity loan proceeds, you can give them cash for a down payment or help pay down their debt to help them get approved.
  • Keep gift taxes in mind when gifting your loan proceeds to your kids.

Use a Home Equity Loan to Help Kids Buy a Home

Before taking out a home equity loan to help your kids buy their first home, consider the rest of the assets that you may have available. If you have other assets such as investment properties, cash savings, or retirement accounts, sit down with a financial planner to see which is the best to pull from for this purpose. You may find that selling an investment property or allowing your kids to live there for reduced or zero rent may be a better option than taking out a home equity loan, especially with current high interest rates. 

Taking out a home equity loan is relatively easy. You’ll need a minimum of 10% equity in your home, decent credit, and proof of income sufficient to pay back the loan. Once you are approved for the loan, the cash is yours to do with as you see fit. Keep in mind that you’ll be making fixed monthly payments, including interest on the amount borrowed for the length of the loan. If you’re 10 years from retiring, make sure that you can still afford to make loan payments after your retirement, or get a home equity loan with a shorter loan term.

Cash for a Down Payment

Giving your kids cash for a down payment may be the easiest way to help them buy a home, but it may not be enough. Gift taxes come into play after the first $16,000 per recipient per year in 2022. If you give $16,000 to your child and $16,000 to their spouse for a total of $32,000, that can provide them with a 20% down payment on a home of up to $160,000. That may sound like a lot of house, but in 2022, the nationwide median home price was $428,700.

Married Couples and Gifting

Even if you file a joint tax return, each spouse can gift up to the gift tax limit. This means that you and your spouse can actually gift $16,000 each to your child and their spouse for a total of $64,000. If you’re married and your child isn’t, you can give your child a total of $32,000.

If your kids are only putting 3.5% down through a Federal Housing Administration (FHA) loan, they could potentially purchase a house up to $970,800 with a $32,000 down payment. However, FHA loans carry additional costs, most notably the large up-front and annual mortgage insurance premiums that stay on for the life of the loan. Additionally, in today’s hot real estate market, some home sellers are hesitant about accepting FHA offers if a non-FHA offer is available, as FHA loans have stringent appraisal and inspection requirements.

Help Paying Down Debt

One of the factors preventing your kids from buying a home may be their debt-to-income (DTI) ratio. Student loan debt reached a record $1.762 trillion in the first quarter of 2022. If your kids have large student loan payments, it may be hard for them to get approved for a mortgage. Most lenders prefer a DTI of 36% or less, which can be difficult for recent graduates to attain with current college costs and entry-level salaries.

If you help your kids pay off their student loans with the proceeds from a home equity loan, you can help them get approved for a mortgage. However, keep in mind that gift tax rules may still apply.

What are the risks of a home equity loan?

There are two main risks with a home equity loan:

  • That you could default on your loan and lose your home if you can’t afford to pay it back
  • That you could become underwater on your loans if your home’s value decreases, making you unable to sell your home without a significant financial loss

Can I co-sign my child’s mortgage?

Yes, you can co-sign your adult child’s mortgage, which can help them get approved for a loan if their income or credit score is insufficient or if they have too much debt. Keep in mind that you’re fully on the hook for the mortgage if something happens and your child becomes unable to pay it back. Co-signing will also affect your own debt-to-income (DTI) ratio, which can affect your future ability to be approved for things like a mortgage or an auto loan.

Who pays gift taxes?

Generally, the giver pays the gift tax to the Internal Revenue Service (IRS), but there are some circumstances where the receiver can make arrangements to pay the gift tax. Check with a tax professional to see what is possible and the best for your situation.

The Bottom Line

If you’re willing to take on more debt to help your kids achieve homeownership, taking out a home equity loan may be the best way to do it. You can use your home equity loan proceeds any way you like, but helping with a down payment or helping them to pay down debt that may be affecting their mortgage approval is the most effective way to help them buy their first home. But before you take out a home equity loan, make sure that you understand its risks.

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