Mortgage rates have repeatedly hit record lows in recent months, which theoretically makes it a great time to purchase a new home. Unfortunately, property values have also gone up due to high demand and limited supply.
With homes so much more expensive, many first-time buyers will struggle to come up with the funds to make a down payment -- even if they could easily qualify for a mortgage at an affordable rate.
If your child is hoping to buy, you may wonder about lending them the money for a down payment in order to help make that happen. But before you extend that offer -- or before you say yes if your kids ask you to borrow -- there are a few things you need to consider.
Lenders will want to know where the money came from
When lenders evaluate a mortgage application, they assess the borrower's debt relative to their income. If you loan your children money, they will need to disclose this to their lender so it can be factored into their debt-to-income ratio (DTI).
A high DTI is a red flag to lenders. As such, if your kids are worried about qualifying, it may be tempting to keep quiet about the loan. This is not a good idea.
First, mortgage lenders will want to know where the money comes from. If you write a check or deposit the money in their bank account, the lender is most likely going to ask for a letter documenting the source of the funds. And you'll need to attest in that letter that the money was a gift, not a loan. Obviously, you don't want to lie in an official document you're submitting to a mortgage loan provider.
You can't afford to compromise your own financial situation
Lending money to your kids is only a viable option if you can do so without putting your own future at risk. You don't want to raid your retirement accounts to help them make a down payment. Doing so could affect your ability to earn the kinds of returns you need for the future. There's also a risk of tapping the equity in your own home (such as by taking a home equity loan or a cash out refinance) since you'll be putting your house on the line.
Of course, you may feel the loan isn't a problem as you're confident your kids will pay you back. But unexpected things could happen. They could lose their job, or become disabled and unable to work for a period of time or permanently. Or, in an especially tragic situation, your child could pass away before being able to repay you. Obviously, you'd have much bigger concerns if that happened -- but you could still end up in a dire financial situation if you've loaned them money you can't afford to lose.
You don't want to jeopardize your relationship
Borrowing money can be damaging in a number of ways. Your kids could feel guilt for being indebted to you, which could affect your relationship. Or if they don't pay you back, you'll probably be angry that they abused your trust.
The last thing you need is to become estranged from your children over financial issues, so think very seriously about whether the loan is worth the risk.
There are benefits to loaning your kids money, too
There are lots of reasons not to loan money to your kids to purchase a home, but there are also some reasons why you might want to make the loan.
Your willingness to loan your children money could make all the difference in their ability to purchase a home at all -- especially in areas where home values are so high that even a small down payment adds up to tens of thousands of dollars. If you're able to loan them money so they can begin to build equity, you could be setting them up for greater financial success in the future.
If your loan enables them to make a 20% down payment, this could also allow them to qualify for more loans at more competitive rates. And they won't have the added cost of private mortgage insurance. However, these benefits need to be weighed against the considerable risks. You should only move forward if you're confident the loan won't leave you without financial security in your later years.