First-time buyers fund their home purchases in a variety of ways. Often, buyers dig into their savings, take out loans, and some have the option of financial support from their family in the form of a gift or a familial loan. Financial support from your family is not available to every buyer, but if you’re lucky enough to have this option, this article is a useful guide.
Should You Accept Financial Support From Your Family?
If coming up with a down payment or qualifying for a lower interest rate will delay your dream of home ownership, financial support from your family can change everything. If you have willing family members with the means to help you out, it’s worth considering. The biggest question is whether the money will be in the form of a gift or a loan. These two distinct options are handled differently from beginning to end. You and your family should consult experts on tax and real estate law so the “i” s are dotted so you won’t get into trouble down the road.
What to Know About Receiving Money as a Gift in Colorado
Colorado doesn’t have an inheritance tax, so you don’t have to worry about paying fees if you’re receiving money through an inheritance. Colorado also has no gift tax, although there are limits to this rule. As of 2022, each individual can receive up to $16,000 per year as a gift without paying taxes on the money. However, you and your parents or other family members still need to follow some guidelines to avoid tax implications and meet lender requirements.
Double-check with your accountant before making any decisions, but a general rule of thumb is:
- Parents can each give up to $16,000 to a child and another $16,000 to their child’s spouse per year without facing a gift tax. That’s $32,000 per person or $64,000 total if both parents give the maximum amount.
- If the gift is recent , a lender needs to see a signed agreement from the parents stating that they have given their child a specific amount of money as a gift. This means they don’t expect repayment. The lender wants the buyer to prove the origin of this new money to fully understand a borrower’s finances.
Early Inheritance
If you and your parents are really organized, the tax-free gift giving can start earlier. With some planning, your parents can gift you $16,000 per year over several years into an account in your name (or double that if you’re married!) In this situation, the gifted money can become more “seasoned” in your account before you even start looking for a home. It essentially becomes your money, and no lender letter is required down the road. However, the potential downside for your family members is that they have no control over how you spend this money. It might never be used for a down payment on a home. It’s really up to you.
Intrafamily Loans
Rather than gifting money, a family member can lend you money to purchase a home. That means you do have an obligation to pay back this money. Setting up this family loan is a little more complicated, but it can be a win-win for both sides.
The benefit of an intrafamily loan is that you can get a lower interest rate than you’d get for a fixed-rate mortgage loan. Additionally, your parents can earn more on the interest from this loan than if their money was in a CD at their local bank.
Keep in mind that there are strict requirements you and your family must abide by. You don’t want to face any gift tax or income tax penalties. You should meet with a real estate attorney to draw up loan documents and set appropriate rates, payback requirements, etc.
The interest rate your parents give you must meet the IRS’s applicable federal rate (AFR) for an “arms-length” transaction. Even so, this rate is likely a way lower rate than you would qualify for through a bank. Plus, this loan won’t have fees, points, or mortgage insurance that can increase your costs.
Hopefully, this article serves as a jumping-off point to start serious conversations about finances with your family. Money can be a tricky subject for families. But, it is good to know there are options out there. Tax laws change every year, so have a professional guide you through the process no matter what. For any other questions about the home buying process, I’m just a click away!
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