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Cash-out refinancing to help your kids buy a home

 

A growing number of parents are helping their adult offspring take advantage of current mortgage rates and more affordable home prices to become homeowners. The 2013 Profile of Home Buyers and Sellers by the National Association of Realtors (NAR) showed that 27 percent of homebuyers received down payment assistance from a friend or relative, usually their parents.

While helping your kids with a gift for all or part of their down payment can be helpful, some parents are opting to provide financing for their kids in the form of a private mortgage for all or part of their home purchase.

Family financing

The rules about how much you can contribute as a gift vary by loan program. FHA-insured loans (Federal Housing Administration) allow the entire down payment to be a gift, while conventional loans limit gift funds according to the size of the down payment. In either case, you'll need to provide a gift letter that states that you're giving the money to your offspring and don't expect repayment.

If you're more interested in financing a loan for your kids, you can do this privately or work with an attorney and tax professional or a company such as National Family Mortgage that provides you with appropriate documentation and records the mortgage with public authorities.

There are tax implications for you and your borrowers if you offer a private loan, so it's crucial to document the transaction and loan payments to avoid gift-tax issues and to allow your borrowers to take advantage of the mortgage interest tax deduction.

You should also consider the personal aspect of loaning a significant sum of money to your offspring and have a plan for what would happen if they miss a payment or pay late.

Whether you're thinking of providing your offspring with a gift or a loan, you may not have the cash on hand to devote to their financial well-being. If not, you can consider tapping into your home equity as a source of funds.

Refinancing to help your kids

Before you take a step toward offering money to your kids, it's important to evaluate your own finances. If you've paid off your credit-card debts, are fully funding your retirement savings and have a plan to pay off your mortgage before you retire, then it may make sense to help your kids become homeowners. If your finances are not in excellent shape, you should take care of your own money management first before you provide for your kids.

If you have significant home equity in your property, such as 50 percent or more, you can opt for one of two solutions:

  • Cash-out refinancing: Refinancing will incur closing costs and, depending on your current mortgage terms and the amount you're financing, your payments could increase. Make sure you refinance up to a maximum of 80 percent loan-to-value to avoid paying private mortgage insurance.
  • Home equity loan: A home equity loan has lower closing costs, but your interest rate is likely to be a little higher than a refinance.

Consult a lender to find out the pros and cons of your individual decision to help your offspring and to choose between refinancing and a home equity loan.

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