If your parents are entering retirement and still living in the same huge house you grew up in, it might finally be time for them to move. Of course, this is far easier said than done -- there are any number of emotional, physical, and financial challenges that come into play.
You can help your beloved progenitors deal with all of those things, but in the near term they may need help on the money part most of all. Reason: Getting a home loan as retirees with a smaller income with today's strict lending standards is a lot different from their time, and they may struggle to get approved. And that's where you come in!
You have several options. One is to offer them down payment assistance, but your parents would then need to qualify for the mortgage on their own, which is going to be tough if they're no longer earning an income.
If that's a no-go, you can either purchase a home outright and let your parents live there; co-sign to help your parents qualify for the loan; or buy a home as an investment property and charge your parents rent.
Not sure which move is right for you? Here are each option's advantages and disadvantages.
Option 1: Purchase the home outright
- For starters, Mom and Dad will be over the moon! (Who doesn't love a free home?) You love those guys, right?
- The home where you live will be your primary residence, and the property you purchase for your parents will count as a "vacation home." There are significant tax benefits to this arrangement, says Lisa Cahill, CPA and co-owner of Evolve Real Estate in St. Petersburg, FL. As with your primary residence, Uncle Sam lets you deduct the mortgage interest and property taxes on the home where your parents live, up to a total of $1 million for the combined balance.
- Unless you've budgeted for this size of a purchase decades in advance (in which case, you truly are son or daughter of the year!), the cash you'd be spending could throw a very large wrench into your retirement savings, says Brandy Wright, a certified financial planner at Cambridge Wealth Counsel in Atlanta. "Some people buy their parents a house without taking a close look at their own long-term savings goals," laments Wright, adding that some people dip into their own 401(k) or IRA to purchase the property.
- If you gift the property to your parents, you may have to pay a gift tax. However, the government allows each individual to gift up to $5.34 million over the course of their lifetime before paying a gift tax. (That's a high ceiling for the average consumer.) A better option: Keep the title of the house in your name, and avoid the gift tax entirely.
Option 2: Co-sign the mortgage
- Depending on their assets, Mom and Dad may be able to qualify for a mortgage if you become a co-signer. Many parents prefer this option instead of having their children subsidize their homeownership costs, says Wright, since they want to maintain some financial independence.
- Your bank account goes untouched: You don't have to put any of your own cash into the purchase.
- You'll be responsible for any missed payments. Hence, "if your parents fall behind on the mortgage, it can damage your credit," says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. "The risk is lower if your parents have had a mortgage in the past and they're responsible with making payments, but there's still some risk involved." If you're concerned, create a joint checking account and set up automatic mortgage payments, suggests Wright.
- If you're co-signing for your parents on a jumbo loan (they needed that lake house, huh?), you'll probably have to meet higher income requirements, says Sheinin.
- If you decide to put the title in your parents' names and they ever need to apply for Medicaid to pay for assisted living or a nursing home, the home could be considered a countable asset and may need to be sold before Medicaid pays for any health care expenses.
Option 3: Purchase the home and charge your parents rent
- For many families, this is a win-win. You get the benefit of having a trustworthy tenant and gain equity in the investment property over time; meanwhile your parents get a place to live for a reasonable rent.
- Since the home is an investment property, you can take tax deductions for repairs, insurance premiums, and other costs. But "make sure you're charging them fair market rent" -- in other words, rent should be similar to that of other properties in the area -- "or the IRS could audit you and the losses would be disallowed," says Cahill. Research comparable rental properties, and charge your parents accordingly to avoid any legal repercussions. Make sure your parents sign a formal lease agreement, says Cahill. Here's where you can read more about the IRS rules on renting to family members.
- Mortgage interest rates for investment properties are higher than for homes that are being purchased as the buyer's primary residence. Down payment requirements are also typically higher, says Sheinin.
- Collecting money from your parents each month might feel a tad awkward. Also, you're responsible for maintaining the property, so Mom and Dad could end up calling you every time they need to change a lightbulb. But hey, maybe you're doing that already.