Parental loans can interfere with adult children’s mortgage applications

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Many parents feel inclined to assist their grown children with purchasing their first home. Whether through a gift or through a loan, it’s common for mom and dad to pitch in with monetary support when their children take this significant life step.

It’s important for parents wishing to assist their children in this manner, to understand the distinct difference between giving a loan and giving a gift. Specifically, the fact that loaning money to children for a home purchase, as opposed to an outright gift, can actually make it more difficult for them to secure a mortgage loan.

Lending risk

Since lenders look at a family loan as additional debt that must be repaid, it can become an unintentional extra hurdle the borrower must overcome during the mortgage application process. A parental loan can in fact significantly raise the borrower’s debt-to-income ratio, possibly causing the lender to turn down their request for a mortgage loan.

Complicating the matter further is the fact that family loans are considered unsecured debt, meaning no asset is serving as collateral. This is generally viewed as an additional lending risk.

Gifts viewed differently

Money that is gifted outright is viewed more favorably, but is not without lender requirements. First, it’s essential for the borrower to provide correct documentation, including a letter clearly stating the amount gifted, and that the giver does not expect repayment. Also required is written proof that the funds have been transferred from the giver’s account to the receiver’s account. The other option is to provide a copy of a certified or cashier’s check. Lenders also typically require the borrower to provide at least 5 percent of the loan amount him or her self. This shows a sense of financial responsibility and indicates that the borrower can manage their finances.

Also keep these considerations in mind:

  • Keep it close — Gifts from unrelated individuals or distant relatives are typically not permitted.
  • Tax rules — An individual gift of $13,000 or less is tax-exempt, but gifts that exceed the $13,000 annual limit must be reported to the IRS.
  • FHA loans — Federal Housing Administration mortgage limits are higher in some areas, and often permit gifts to cover the entire down payment.

If you’re a parent considering offering down payment assistance to your child, or you’re a homebuyer seeking help from your parents, keep these important considerations in mind. It could mean the difference between being approved or denied for a mortgage loan. 

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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