Today's kids find it increasingly difficult to finance a first home. Parents, motivated by a desire to provide financial security for their children, are helping with a so-called "parents-backed mortgage." This shared equity financing arrangement is an increasingly popular tool for assisting kids, and can provide mom and dad with extra income from real estate appreciation.
Just a few years ago, the average price of a single-family residence was around $125,000. You could also get a small home or condo in the $75,000 range. Home ownership was not just a dream, but a reasonable, attainable financial goal for many young people. But within a few short years, prices doubled. The cost of housing in the U.S. has risen so high so quickly, that many young people face nearly impossible hurdles when trying to pay for a starter home.
Parents to the rescue
Even if prices are slightly lower this year, credit is tighter. As a result, young people need as much help as they can get. Parents are the most likely source of that aid. One of the most popular solutions is the parents-backed mortgage, an arrangement that can also boost the retirement income for the burgeoning demographic of baby boomer mothers and fathers. Parents-backed mortgages can also be a healthy alternative to risky interest-only mortgages, piggyback loans, and adjustable-rate mortgages that can leave some young homeowners saddled with debt or in danger of foreclosure because they borrowed more than they could afford.
Making it happen
Rather than giving money to a child outright, the folks enter into a written equity-sharing arrangement based upon mutually agreed upon terms. Even though the terms are flexible, it should always involve a written contract that spells out everyone's responsibilities. For instance, parents might agree to contribute 30 percent of the down payment in exchange for 30 percent of the home's equity appreciation. Mom and dad can co-sign if they want to, or choose to keep their names off the mortgage documents. And while many insist that the investment be paid back (either through a sale or a refinance) by a specific date, all these terms and conditions are negotiable.
Negotiating a deal
Clear communication can make a fair arrangement for everyone. Use an attorney to draw up the documents so that they're official and legally binding. The homeowner-in other words, the child-is typically responsible for making mortgage payments on time, and gets the appropriate year-end tax deduction. Payment of property taxes can be the responsibility of the homeowner, or the folks can pay a portion or split the costs equally.
When the house is sold-hopefully for a substantial profit-mom and dad not only get their original investment back in the form of a loan payoff, but they're also entitled to their share of the return on equity. If the kids buy into a bear market and sell or refinance after the market bounces back, this kind of arrangement can give parents a welcome infusion of cash for retirement.