Tomorrow is Pearl Harbor Day, memorializing the attack on our Naval fleet at Pearl Harbor, Hawaii on Dec. 7, 1941. I’m sure there are many people who still live on Anna Maria Island who will either remember the events of that day or learned about them in school like I did. But what does Pearl Harbor have to do with family and finance? Family has always been important and still is, but in the aftermath of the Pearl Harbor attack and the subsequent entrance of the United States into World War II, family ties became even more important.
With rising interest rates and slowing real estate sales, home ownership remains out of reach for many buyers, especially first-time buyers. Here’s where family ties come into play. One option available to help young buyers, especially those with poor credit ratings, is to have parents cosign the mortgage. A qualified cosigner can mean the difference between a buyer getting a mortgage approved or staying in their one-bedroom rental. However, parents who may be perfectly willing to take this leap need to understand what their liability is.
Individuals who cosign a mortgage are totally liable for repayment of the loan, but are not owners of the home. Therefore, if your children stop paying the mortgage, you have no way to force them to sell the property. You’re stuck with all of the monthly payments but don’t have the typical rights of a homeowner.
Parents can, however, have all the rights of an owner if they become an investor in the property instead of just a cosigner. This at least gives them co-ownership in the property and vastly more decision-making ability. No matter what is decided within your family, cosigning is a risk for parents who may be getting ready for retirement and can’t afford to risk their investment if things don’t turn out as planned.
For family members who have the financial ability, holding the mortgage for a family member is another option to help out children or other family members get into a home. Basically, the parents would act as the bank, and the children would pay back the mortgage based on agreed terms. It could be a win-win situation for all; the parents have the opportunity to help their children and the children end up with a much lower interest rate than commercially offered. There are IRS regulations that set a minimum interest rate for loans between family members to be considered.
This type of arrangement should have the appropriate legal paperwork that will satisfy the IRS that it is not a gift. Cash gifts to anyone, including children, have specific regulations on the amount of a gift that can be given without any tax due. Registering the loan as a mortgage on the property at the local government office provides more benefits as well. The children can claim a mortgage-interest deduction for the mortgage debt, again with a limit based on federal tax regulations and their personal tax bracket.
Under the best of circumstances, entering into a financial arrangement with family members can be a challenge. There could be arguments about the maintenance of the property, jealousy from other family members and possibly a big financial risk for the cosigner or lender of the funds. Not something to enter into without considerable thought and professional assistance.
Franklin Roosevelt’s famous speech shortly after the Pearl Harbor attack ends with “a day that will live in infamy.” Keep that in mind when entering into a business arrangement with family, try to avoid your day of infamy.
