Give your kids the gift of equity
By JEFF LAZERSON / CONTRIBUTING COLUMNIST
A great way for first-time buyers to avoid the home shopping rat race, high-price pressure and scraping together a down payment is taking over a property that your parents own, or perhaps one that they inherited.
We are assisting a small stampede of these lucky ducks asking for home financing help. Sometimes the kids are already living in the property as tenants and sometimes they are living elsewhere (like with mom and dad).
The gift of equity often can replace the need for a child to make a down payment to get new financing on a home that’s being transferred from one family member to another.
Such “purchase loans” through Fannie Mae or Freddie Mac require a minimum 20 percent gift of equity.
The Federal Housing Administration (FHA) requires a minimum 15 percent gift of equity. The minimum gift of equity drops to 3.5 percent if the property was occupied by the child prior to sale (other conditions apply as well).
If you have the equity and stronger credit credentials to qualify, conventional financing is cheaper than FHA financing. This is due to the mandatory FHA mortgage insurance, which is not required for a 20 percent down conventional loan.
Here’s an example: The property is worth $600,000 and there is a $300,000 loan against the property. At minimum, mom and dad can sell the property to the child for $375,000, providing a $75,000 gift of equity for the child’s down payment.
The child does a no-cost, no-fee loan by accepting a slightly higher interest rate. Parents pay off their loan through the sale and clear get their names off the title.
New home-sweet-home for the child requires no money down. Nice!
Using the same example, let’s say mom and dad want to cash out $100,000 of equity. That means the new loan must be for $400,000.
So, to determine how much to add for the 20 percent gift of equity, we divide $400,000 by 0.8 (since $400,000 will equal 80 percent of the final “purchase price”). We a sales price of $500,000.
The new homeowner still enjoys $200,000 of real equity.
According to the Orange County Tax Assessors Office, Proposition 58 allows the child to retain the parents’ lower property tax basis as long as they properly file papers with the county within 3 years of the transfer date.
Children could also gift to parents, although it is uncommon. And, a separate law allows grandparents to gift to grandchildren.
“If the gift of equity is over $14,000 from one parent or $28,000 for both parents, you have to file a gift tax return,” said Warren Hennagin CPA and managing director at Glenn M. Gelman & Associates. The good news for the parents, Hennagin said, is that the parents have a $1 million lifetime exemption for total gift tax.
So, the parents can gift up to a million dollars between all of their kids and still not have a taxable event.
Fannie, Freddie and FHA require owner occupancy to get financing involving gifts of equity.
If there is enough equity, the very best Fannie pricing available is when you provide a 40 percent gift of equity. It won’t affect the current property tax rate. And, you’ll keep the neighbors happy if you push the sales price closer to the actual market value.
Jeff Lazerson - Mortgage Columnist since 2011