Buying a home for your parents to live in is basically buying a second home with another mortgage added to your monthly bills. That can be difficult to do, though there are two other options if adding another mortgage bill to your finances isn’t possible.
All of these come with various pros and cons that children should look into before buying a home for their parents. The reasons for such a move vary, starting with the idea that children want their elderly parents living closer to them.
“It’s becoming very common,” especially in areas such as California where housing costs are high and parents live in the Midwest or other inexpensive areas, says Casey Fleming, a mortgage advisor in Silicon Valley and author of “The Loan Guide: How to Get the Best Possible Mortgage.” Buying a house for parents from Ohio may be the only way a highly paid engineer in California can convince them to move closer, Fleming says.
“There’s not a chance in hell that mom and dad could buy a house out here in California,” he says.
Other reasons are that grandparents may want to live closer to their grandchildren, or that their current home no longer meets their needs and they want to move but can’t afford it on a fixed income.
Whatever the reason, there are three main scenarios when buying a home for parents to live in:
1 - Buying a second home yourself
If you can afford a mortgage on a second home, then buying a second home and letting your parents live there is the best option.
But first you should know how a second home mortgage works and how you want to list the property on the home loan. Is it a second home or investment property? There are differences, and they can affect the loan rate and your taxes.
“If you can qualify — if you’ve got the income and the assets and the credit,” then buying a home for your parents is a smart option, Fleming says.
When paying taxes on a second home, you can still deduct the mortgage interest and property taxes on the second home and your primary home. However, if you already a second home and have mortgages on it and your primary home, you can only claim the mortgage interest deduction on two of three properties if your buying a second home for your parents. We’ll get into taxes on investment properties in option No. 3.
Second home mortgages usually have higher upfront costs and interest rates, Fleming says. A larger down payment is usually required on a second home, and income requirements can be twice as high to offset the lender’s increased risk, he says.
You might be able to get you first mortgage with a very low credit score, such as 580, but a higher credit score will be needed to qualify for a mortgage on a second home, he says.
Another option to buy a second home is to use a home equity loan on your primary home for a cash-out refinance that will likely give you a lower interest rate than another mortgage would.
If you do take out a mortgage to buy a second home, you’ll have to list it with the bank as a second home or investment property if you don’t plan on occupying it as a primary residence. A loan for a second home, also called a vacation home, has lender rules in a conforming mortgage that it must be at least 50 miles from your primary home.
But there’s an option to get around that: the Family Opportunity Mortgage authorized by Fannie Mae and Freddie Mac. This loan option waives the 50-mile rule and is meant for children buying a home for a parent who is unable to work or qualify for a mortgage on their own.
The loan has the same qualification terms as a mortgage on a primary residence, with a lower interest rate and down payment.
2 - Helping parents buy a home
Giving your parents some financial assistance to buy a home, instead of buying them one outright, can help your finances and make them the owners of the home instead of you.
Children can give their parents the gift of a down payment on a home and don’t have to be listed on the loan, Fleming says.
For children who don’t have the income to afford a second home, another option is to be a non-occupant co-signer (also called a co-borrower) on a home loan for a primary home for their parents. The children would accept the responsibility that mortgage payments are made, just as their parents would, and the children would cover any lapses in mortgage payments.
“The downside for the children is they’re now on the hook for that debt,” Fleming says.
Loan programs vary for co-borrowers. Some allow the parents’ and children’s incomes to be counted together to qualify for the loan, and others may require each to meet certain income standards.
The down payment shouldn’t be higher and the interest rate shouldn’t be higher than it would be a mortgage on any other primary home, Fleming says, mainly because lenders are looking for business.
“Lenders right now are so hungry, they’re loosening up funding,” he says.
For tax deductions as a co-borrower, either the child or parent can take the deductions on the parents’ home, or both can as long as the deductions are split and don’t add up to more than 100 percent of what’s allowed, Fleming says.
3- Become parents’ landlord
The last main method to helping your parents live near you is to buy a home and rent it to them. This option can have all of the benefits of being an investment property owner — such as deducting rental property expenses on your taxes — and all of the downsides of it.
If your parents can’t qualify for a mortgage on their own or can’t afford it even if you help make the payments, then renting it back to them at a price they can afford may be a better option.
However, renting to them at a below-market rate won’t allow you to claim all of the tax deductions that you normally would as a landlord because the home is considered for personal use only, says Priya Mishra, managing attorney at Top Tax Defenders, a back tax resolution firm in Houston.
“One way to get around this is to be able to claim your parents as dependents,” Mishra says. “You can claim your parents if they make a certain amount of income and you pay more than half the support costs.”
There are many tax, legal and financial complications when renting a home to you parents. Seek good legal advice before proceeding.
For lending purposes, investment property loans will have higher interest rates and fees than other types of home loans. A down payment as high as 25 percent may be needed.
“Lenders are cautious on rentals because during the financial crisis everybody walked away from the rentals,” Fleming says.
One last issue
If you co-sign a home loan with your parents or give them some type of financial assistance to buy a home, it could jeopardize their eligibility for Medicaid.
It’s a needs-based assistance program, and certain types of financial assistance such as help buying a home could be considered a countable asset if the home is in the parents’ names.