Co-ownership can solve down payment shortagePat Curry •
Bankrate.com
Anyone who's in the market for a first home knows that
it can take some real creativity to come up with the necessary funds
to get into a house. Low interest rates and escalating land values
have driven up prices in most markets, and that means higher down
payments.
So how is a young person supposed to buy a house?
To be sure, there are many conventional strategies,
including having a parent co-sign on the loan. But that can be risky
for the co-signer, who has all the responsibilities but none of the
benefits of obtaining a mortgage. If there's a need for a tax
deduction, it may make more sense for parents to actually become
co-owners of the property.
Of course, there are some potential downsides to
co-ownership, including family fall-outs and possibly a higher
interest rate. But there are plenty of advantages too.
Co-ownership agreements are done every day. Usually
the borrowers are husband and wife, or two people in a relationship
who decide to buy a house together. The thing they have in common is
that they plan to live in the house, known in mortgage lingo as
owner occupancy.
Helping children find home
Parents who
decide to sign on the bottom line as a co-owner generally aren't
planning to move in. That makes the deal investment property, says
Christopher Shaxted, executive vice president of Lakewood Homes in
Chicago. It's a great way, he says, for a first-time home buyer to
buy a larger house.
"Where I see it is a first-time buyer goes out, buys a
house in line with their budget or does a little stretch, but it's
not as much as they should have because in five or seven years they
need a bigger house, but they like where they live," he says. "This
gives them an opportunity to upsize."
The concept definitely has merit in certain parts of
the country. That's the situation that CPA and tax attorney Scott
Haislet sees in San Francisco. Older residents who bought their
houses decades ago and own them outright have seen astronomical
appreciation in the value of their homes. Meanwhile, their children
are shut out of the market.
"Around here, it's very difficult for someone who has
never owned property to get into a house," he says. "For a lot of
younger people, the best source of assistance often will be a parent
with an open mind and a lot of equity."
In New York City, they call them 'kiddie co-ops,' says
Ellen Bitton with Park Avenue Mortgage Group. She sees them in about
one in every 25 applications. Usually, she says, there's an ulterior
motive. A parent is looking for a way to give his child some money,
or he recognizes that his child's own credit history isn't going to
be enough to qualify for a loan.
"Those are the two biggest things," she says. "There's
always a possibility the parents want the investment. They might be
able to take more of the tax advantage. The way it's been explained
to me, as long as only 100 percent of the tax deduction is taken,
the IRS doesn't care who takes it."
Shaxted says the arrangement has been around since the
1980s, when interest rates were through the roof.
Parents as landlords
Today, not many people
take advantage of it, but it's worth considering if you're in a
higher tax bracket and looking for deductions.
"It works best for people just starting off with
relatively low incomes who don't care as much about the tax benefit
as the person in the 36- to 40-percent tax bracket," he says.
| To take the tax deduction, "You really do need to rent the
property," he says. That requires drawing up an agreement that says
how much of the property the parent owns and collecting a portion of
the payment as rent.
The ultimate goal is for the children to buy out the
parents and own the house outright. The time line for making that
happen can be spelled out in a co-ownership agreement. Until that
happens, the parents and children can split the tax deductions, and
are entitled to their part of any appreciation and profits gained if
the property is sold.
Peter Bielagus, author of the Penguin Putnam NAL book Getting Loaded: A Complete Personal Finance Guide for
Students and Young Professionals, can attest to the problems that
young adults encounter in coming up with a down payment.
"Adding a parent into the mix can make that happen," he
says. "Co-owning is a way for parents to diversify into real estate
... Wouldn't you love to have an investment property where you say,
'I've known this tenant for 26 years'?"
The most important part of the process, Bielagus says,
is upfront communication and understanding each other's goals. Parent
and child need to agree about the division of the tax deductions, and
any proceeds if and when the property is sold.
In the Los Angeles area, real estate agent and mortgage
broker Silva Mirzoian says she sees a lot of co-ownership deals, with
parents buying condos or houses with their children who are going to
college. With the child's name on the title, it helps him build credit
for buying his next house.
"It helps to teach the kid the responsibility of a good
credit history," she says. "If anything does ever happen, there's an
upfront equity built into the house. I look at it as a future
investment for the child and parent. Hopefully, they're buying at the
right time and place. It's better than just giving them the down
payment. The parent has had the interest write-off for those years and
now the child has a future. It's a great thing."
Disadvantages of co-ownership
Other lenders
are less enthusiastic about the deals. Los Angeles-based mortgage
broker John Loftus with First West Lending Corp. says he's seen plenty
of parents give their children money for a down payment, but he's
never had a parent put his or her name on the title of a piece of
property and not actually live there.
"If the parent isn't living there, I think underwriters
would question that," he says. "If you're the primary borrower, you
have to be listed as a non-owner occupied investor."
If that's the case, you can plan on paying a higher
interest rate for the loan, usually about a percentage point higher,
he says.
There are other potential drawbacks too, most of them
related to making major purchases with other family members. If the
child is single, what happens when he gets married? If he gets
divorced, how is the property divided?
If the parents and child have a falling-out, bad
feelings can quickly turn into bad financial situations. If you want
to get back at Mom and Dad, what better way than to say 'no' to
selling the house, tying up their money and keeping them from getting
a nice return on their investment? The same holds true for parents
trying to teach Junior a lesson.
"People always want to tippy toe around those," Haislet
says. "On a gift, you gave it away, so you may just be ticked off. If
you're an equity owner and there's some kind of responsibility for
formerly married children to pay, you're now a partner of an estranged
family member.
"You may be subject to rules of tenants in common. You
have to go to court and sue the other person who's unwilling to sign
and have to demonstrate why it's a good reason to sign. The court
takes control of the title, orders it sold, and the net proceeds are
split between you. Hopefully, your agreement says you get your money
back first."
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