“How can we help our children buy their first home?” It’s a question people my age are asking. Generation X and Baby Boomers are long real estate, with second and even third homes, and we have (multiple) children of child-bearing years who now need help with the down payment buy a first home. What’s changed in the run-up of the last 5 years is that “getting into the game” now means a starter home of around $1.25 million in most major cities and their commutable neighborhoods. Conventional wisdom suggests a quarter million-dollar downpayment is required on that loan and usually you can’t borrow the downpayment. As a father of four how can I make even that first quarter million-dollar gift efficiently over time? What if I need that money before I die? This is a case study in liquidity, borrowing limits, tax efficient giving, and flexibility.
The New Strategy:
It is possible to buy a home with 3% down. Fannie Mae’s “Conventional 97” and Freddie Mac’s “HomeOne” are available to first-time homeowners with no income limits, a credit score of 620+, and are limited to $806,500 in “standard areas”. The run up in prices means in a lot of areas we need to super-size the loan, now $1,209,750 in high-cost areas (but oddly not Fairfield County). This presents challenges for both down-payment and monthly payment.
Consider Hell’s Kitchen where a 1-bedroom rents for $5,000 per month. There’s a 2-bedroom, 1 bath condo asking $1.2 million at 505 West 47th Street, a newer luxury condo with amenities. I say Manhattan, but it’s true in Georgetown and New Canaan, Boston and Brickell (Miami).
Rates and Ratios, Failing to Qualify:
I found a 7/6 ARM quoted at 6.25% but if this is a forever home we can “buy-down” a jumbo 30-year fixed mortgage to 6.125% and $7,070 per month. HOA + taxes are $2500, and we’ll estimate primary mortgage insurance is $500. Monthly total comes to $10,000. Will we qualify? No. Debt payments can’t exceed 43% of income (45% for some jumbo loans). Housing costs (mortgage + taxes + HOA + insurance) can’t be more than 30% of gross monthly income. To afford that apartment we’d need $32,000-month in gross income, $385,000 per year. Few jobs pay that kind of salary. How can we make it work with an annual household income of $250,000., 20% of the total cost?
Should we start looking at smaller apartments without a doorman or elevator? Perhaps. But if the purpose of the exercise is the tax-efficient transfer of wealth to our children over time to support home ownership and give our children more options (and to deplete our estate more gradually) then let’s tweak the model:
New Assumptions, Eliminating PMI By Gifting the Down Payment:
If $250,000 is my child’s combined annual household income this translates to $20,833 per month. Under the 43% DTI ratio, their maximum allowable monthly debt payment would be $8,958. This is the amount that can be spent on all debt obligations, including the mortgage, property taxes, HOA, and insurance.
With a mortgage of $960,000, my child would be looking at a monthly mortgage payment of about $5,800. Adding $2,500 for taxes and HOA, her total housing cost would come to about $8,300—below the $8,958 DTI limit.
Now, here’s where we come back to a crucial point. By covering the 20% down payment with gifts and a forgiveable family loan, the loan-to-value ratio (LTV) drops to 80%, which means PMI is no longer necessary. Private Mortgage Insurance is typically required if the borrower puts down less than 20%, but in this case, the foregiveable family loan covers enough of the down payment to eliminate PMI, further reducing monthly costs. Down payments typically can’t be borrowed but this is the great exception: family loans, properly documented, in writing, with a repayment plan and interest rate that meets IRS AFR standards. If the loan is intended to be forgiven over time, it’s treated as a gift for tax purposes. You can forgive up to $18,000 per year per parent under the annual gift exclusion without triggering gift taxes.
In this case, we can provide our child with a gift of $36,000 (tax-free, within the annual gift exclusion) for the first part of the down payment. The remaining $240,000 can be structured as a “forgivable family loan” at an interest rate of 4.6% (matching the IRS’s Applicable Federal Rate, or AFR). This keeps the payments manageable and allows the parent to gradually forgive the loan as part of estate planning.
Why a Trust Works for Flexibility and Control for Gifting and Loaning:
To protect my assets and maintain control over the funds, I used a revocable living trust. This structure ensures I retain flexibility, but I can still gift the down payment or make a family loan, and the money will not be taxed at the time it’s transferred.
This structure also ensures that I maintain control while still helping my child make the purchase. The trust allows me to loan money at an interest rate that’s low enough to qualify for the mortgage, while still making the loan forgiving over time (as long as it stays within the annual gift exclusion limits). One day I might need the money to live, and my daughter might need it less. The trust gives the two of us some flexibility.
The Bottom Line:
What we’re really doing here is leveraging the 43% DTI and using a forgivable family loan to help cover the down payment so as not to trigger PMI. Banks won’t allow down payments to be loaned, but they classify forgivable family loans as a gift. This makes it possible for a child to buy the $1.2 million condo under Fannie Mae’s guidelines.
Challenges:
Not all jumbo programs allow for <20% down. Some FTHB programs have income limits. Gift sooner rather than later. Assets must be “seasoned” in the child’s account for at least two months. The foregiveable family loan must really be a gift not to be considered a liability and count against DTI.
Conclusion:
In this case study, we’ve made assumptions to reflect today’s market and loan conditions. With gifting and the right structure our children can buy their first home in a way that helps them build equity without sacrificing our financial security. It’s all about tax-efficient strategies, careful loan structuring, and leveraging gifts and loans in the right amounts.
John Engel is a father and a real estate broker with The Engel Team at Douglas Elliman, but he’s not a banker or lawyer. This article is not intended as tax or mortgage advice. For guidance on your specific situation, you should consult a tax pro, an estate attorney, and a banker. Call Chuck Threshie, Sr Mortgage Banker with Total Mortgage 203-984-3892. John did.
Check out John Engel’s Podcast, Boroughs & Burbs, the National Real Estate Conversation here.
Read this article on the New Canaan Sentinel website here.
