On selling home to a child

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RetiredMule
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On selling home to a child

Post by RetiredMule »

Dear BHs,

If there is any previous thread on this very topic, kindly alert me to that - I didn't find it on a quick search.


This topic is for discussion on the idea of parents selling their paid off house to a child in the state of California: assume there are no concerns about whatever happens financially, down the road. (i.e., kid financially disciplined, capable of making mortgage payments, no concerns on financial stability of the child etc.). "Seller financing" assumed - the main reason for the parents financing the mortgage is for the interest income to go the parents, instead of a mortgage company/bank.

The child becomes responsible for monthly mortgage payments to the parents, property tax, insurance and all the good stuff that come with being a homeowner. Please comment on possible issues, primarily on any legal gotchas/caveats to look out for.

Planning to involve a Realtor only for consultation/facilitation purposes (arranging for forms, home inspection/appraisal/title company for closing etc.). Since the buyer is already identified, there is no marketing/showing property etc. involved, so, will try to negotiate a fixed fee (say a couple of thousands) for the Realtor's time/commission.

Questions:

1) Since this is a "seller financed" sale, where the parents are selling the house to the child on standard mortgage terms (reasonable interest rates, market value as the sale price, etc.), any thing else to look out for on this (assume no defaults)?

2) Other than down payment and fees involved for closing, any need for any other finance to be arranged for closing, since the loan is issued by the parents? ( i.e., the parents do not need to receive the settlement for the full sale amount from the child, except documenting the terms of the loan and down payment).

3) Any other legal/procedural/financial issues/caveats on this?

Thanks for your inputs...

-RetiredMule
Gill
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Re: On selling home to a child

Post by Gill »

If this is a bargain sale at less than FMV you may need to file a gift tax return for the difference.
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Goal33
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Re: On selling home to a child

Post by Goal33 »

If I am a child I am asking myself “why do I buy this home from my parents at full market value when they’d have to pay a 4.5-6% commission to sell it to a stranger?”
CppCoder
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Re: On selling home to a child

Post by CppCoder »

Goal33 wrote: Sat Oct 21, 2017 2:32 pm If I am a child I am asking myself “why do I buy this home from my parents at full market value when they’d have to pay a 4.5-6% commission to sell it to a stranger?”
I might also look at my parents' age and health and ask why I'm buying it at all if I might get it through inheritance with a stepped up basis.
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dm200
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Re: On selling home to a child

Post by dm200 »

Planning to involve a Realtor only for consultation/facilitation purposes (arranging for forms, home inspection/appraisal/title company for closing etc.). Since the buyer is already identified, there is no marketing/showing property etc. involved, so, will try to negotiate a fixed fee (say a couple of thousands) for the Realtor's time/commission.
Might there be a lower cost alternative, such as a real estate attorney - who could provide only what was needed for just a few billable hours?
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Re: On selling home to a child

Post by 123 »

If the child is married or marries and there is marital difficulties/divorce there is a possibility of very messy divorce/foreclosure situations arising from family deals like this. Sometimes it's just better for all concerned to just sell the property to an outsider, for a higher price, and keep the finances between parent and child(ren) separate.
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dm200
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Re: On selling home to a child

Post by dm200 »

Questions:
1) Since this is a "seller financed" sale, where the parents are selling the house to the child on standard mortgage terms (reasonable interest rates, market value as the sale price, etc.), any thing else to look out for on this (assume no defaults)?
2) Other than down payment and fees involved for closing, any need for any other finance to be arranged for closing, since the loan is issued by the parents? ( i.e., the parents do not need to receive the settlement for the full sale amount from the child, except documenting the terms of the loan and down payment).
3) Any other legal/procedural/financial issues/caveats on this?
Thanks for your inputs...
Make 100% sure that BOTH the buyer and seller (holding the mortgage) accurately and precisely calculate the amortization of the loan over the scheduled period (to the penny). Make 100% sure monthly payments (split PITI) are accurately recorded and calculated. Make 100% sure the extra payments and short payments, etc. are accurately calculated (to the penny). For all of these, make 100% sure statements are provided and both buyer and seller keep full and proper records. My guess is that the overwhelming majority of buyers and sellers are not capable of doing it accurately and precisely.
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dm200
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Re: On selling home to a child

Post by dm200 »

Example of "family friction": My late father offered to refinance my brother and sister-in-law's mortgage at a favorable interest rate. They took him up on the offer and my father-in-law wanted and got a lien recorded for this mortgage. It turned out that my sister-in-law was "insulted" or "hurt" by her husband's father insisting on the mortgage lien being so recorded.

At one point when she brought up this issue at some family event, I said nothing (one way or the other). [There may have been some other things going on in the family as well, but I was not involved].
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Re: On selling home to a child

Post by stan1 »

If you decide to use a realtor anyways negotiate a fixed rate not a percentage of value. You could also use an attorney. Key would be getting an independent appraisal to demonstrate that child is paying fair market value in case there is ever any question about whether this was a sale or gift.

Assuming the child and spouse are qualified borrowers I don't see a whole lot of benefit for anyone to having the parents be the lender. Too many complications can arise that may be unanticipated or unlikely but possible. What if child loses job? What if child passes away? What if child becomes disabled and can't work? What if there's a divorce? I would let a financial lender assume those risks over 20/30 years a typical mortgage covers. Execute the transaction and be done with it. Parents can always gift money back to kids if needed. Parents may earn a better rate of return investing in a diversified portfolio of equity and bond index funds.
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dm200
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Re: On selling home to a child

Post by dm200 »

stan1 wrote: Sat Oct 21, 2017 3:06 pm Assuming the child and spouse are qualified borrowers I don't see a whole lot of benefit for anyone to having the parents be the lender. Too many complications can arise that may be unanticipated or unlikely but possible. What if child loses job? What if child passes away? What if child becomes disabled and can't work? What if there's a divorce? I would let a financial lender assume those risks over 20/30 years a typical mortgage covers. Execute the transaction and be done with it. Parents can always gift money back to kids if needed. Parents may earn a better rate of return investing in a diversified portfolio of equity and bond index funds.
I agree completely. With a regular lender, you can be assured as well that the loan calculations (as I posted) are near certain done accurately and precisely.
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Re: On selling home to a child

Post by JGoneRiding »

Why involve a real estate agent? I believe CA is like WA in that title companies are the standard. They do all the real work. Simply submit a signed purchase agreement to them. And they will make sure everything is checked and recorded. All a real estate agent does is help identify a buyer. That part is done.

I will add at least here the title companies also know which entities do loan management for owner financed deals. They handled all the paperwork for that too when I did one. The loan management company made sure that everything was recorded correctly on both ends for both collecting interest and reporting interest for deductions. It was really easy
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RetiredMule
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Re: On selling home to a child

Post by RetiredMule »

Thanks for all your responses so far!

As I mentioned in my original post, the sale is being planned for fair market value, at reasonable/prevailing interest rates on the loan. So, no gift in the picture.

Fair point about charging a realtor's commission was raised in one of the responses. Fully agreed; the sale price will be adjusted appropriately, esp. for a child :happy

On JGoneRiding's excellent suggestion: will check out the route of just involving a title company.

Thanks again!
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Watty
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Re: On selling home to a child

Post by Watty »

Even if things are set up well and working well then one potential problem is that in five years interest rates and inflation could be much higher and having a low interest rate mortgage would be a very bad thing for the parents.

Just for diversification I would not do this if the the loan amount would be more than 5% of your net worth.

If rates go up and the kid has a great interest rate then they might even decide to move and keep the house as a rental which would be fine with a normal mortage but that could be awkward if you are being paid less than inflation in a few years.

If you have more than one kid then letting them have the house with you holding the mortgage might not seem fair to any other kids. At the very least you would want to update your wills so that the mortgage does not go to your estate someday and you end up with any other kids owning part of the mortgage on the house for the next 20 years.
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Re: On selling home to a child

Post by msk »

I had gone through a few episodes of lending money to relatives at "fair" market rates over shorter periods, maxing out at a couple of years. Main issue is the discomfort that arises when things go bad for the borrower relative. You know that he/she struggles to meet the payments, and they are met, but you cannot afford to tell him/her to skip a few months. I think, as mentioned in a post above, sell to the son (he obviously likes the house) and let him use a regular mortgage. Invest the cash proceeds in your regular portfolio. It should be possible to effect the sale privately or at a drastically curtailed RE brokerage commission rate. He'll inherit your regular portfolio anyway :greedy
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Re: On selling home to a child

Post by nerdymarketer »

From a purely financial perspective, under current tax law, the best thing may be to keep the house in the parents' name and then at death to give the house to the child. Given how much many California houses have appreciated, the step-up in basis at death can be a major tax savings if the child later chooses to sell the house. Financially the only real risk is of tax-law changing, and if that removed the benefit to waiting then you could execute the sale to the child immediately.

However, as everyone in this thread has noted, this is extremely risky from a family relationships perspective. Only you know your family; I am confident this would work just fine in mine, but I'd guess that it wouldn't in 98% of my friends' families. If I were the child, I'd be very transparent with all my siblings about the understanding I had with mom and dad so that there are no surprises when the will is read.

And it does make sense to me to have some kind of compensation for the house that forces the child to immediately start feeling the cost/responsibility of owning the house. There is likely some creative and fully-legal way that the child can "compensate" you in some form or another without actually selling the house to the child and losing that step-up benefit. Philosophically, I wouldn't want the child thinking "this house is my inheritance so it costs me nothing, plus I get to enjoy it early"... that breeds freeloading rather than a sense of ownership and responsibility.
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Re: On selling home to a child

Post by boomer »

I have done some reading as far as taxes go regarding this, because there is a chance we may do something similar. So you might want to read up on the tax law, or consult a CPA.

From what I understand, it may be better to sell the house to your child at full price, to avoid an issue with the IRS. You could then gift your child some funds in a separate transaction, if you wanted to. Currently you can give $14,000 per person per year.
If you are carrying the mortgage and plan to charge interest, there is a minimum federal rate. If you don't charge at least that rate, the interest that you don't charge would also be a gift. If you do charge interest, it would be good to have the payments go through a title company so that the interest is recorded and is tax-deductible for your child.
I don't think you need to involve a realtor. It seems you should be able to take care of the documents with a Title company.
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Re: On selling home to a child

Post by denovo »

RetiredMule wrote: Sat Oct 21, 2017 2:21 pm
3) Any other legal/procedural/financial issues/caveats on this?

Thanks for your inputs...

-RetiredMule
Since you mentioned fair market value and a market-based loan, why doesn't son just go by another home in the neighborhood and get a loan from a boring bank?
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dm200
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Re: On selling home to a child

Post by dm200 »

RetiredMule wrote: Sun Oct 22, 2017 12:03 am Thanks for all your responses so far!
As I mentioned in my original post, the sale is being planned for fair market value, at reasonable/prevailing interest rates on the loan. So, no gift in the picture.
Fair point about charging a realtor's commission was raised in one of the responses. Fully agreed; the sale price will be adjusted appropriately, esp. for a child :happy
On JGoneRiding's excellent suggestion: will check out the route of just involving a title company.
Thanks again!
In addition to paying no real estate sales commission, there are (or may be) other savings on such a sale. There may be much shorter dalays because the house is not idle while being listed and shown. The sale/settlement can be scheduled at a more beneficial date. There may not be the usual "fixup" expenses when listing a house. There may not be the costs, etc. of extra moving of furniture and furnishings.

These kinds of savings could justify (and be very fair to sellers) an added 1-2% of the sales price as a reduction.
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Re: On selling home to a child

Post by SimonJester »

I see no advantage for your child to enter into this arrangement and for me would be too risky towards my relationship with my child. 30 years rates are running about 3.75, you could get a better return in the market with less risk in my opinion.

As others have pointed out mixing finances and family is not a good idea, it changes your relationship from parent - child to lender - borrower.

Another disadvantage if you are carrying the loan, would you be able to report that to the credit agencies so it shows up and helps you child's credit rating?
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dm200
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Re: On selling home to a child

Post by dm200 »

SimonJester wrote: Sun Oct 22, 2017 9:01 am I see no advantage for your child to enter into this arrangement and for me would be too risky towards my relationship with my child. 30 years rates are running about 3.75, you could get a better return in the market with less risk in my opinion.
As others have pointed out mixing finances and family is not a good idea, it changes your relationship from parent - child to lender - borrower.
Another disadvantage if you are carrying the loan, would you be able to report that to the credit agencies so it shows up and helps you child's credit rating?
Down the road a few years, if the sellers have the mortgage and they want/need more liquid funds, there may be challenges/issues. The buyers would then need to refinance (and pay the costs) the mortgage outside. There might even be reasons they could not qualify at that time (even if they can and do make the monthly payments on time).
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Re: On selling home to a child

Post by staythecourse »

SimonJester wrote: Sun Oct 22, 2017 9:01 am I see no advantage for your child to enter into this arrangement and for me would be too risky towards my relationship with my child. 30 years rates are running about 3.75, you could get a better return in the market with less risk in my opinion.

As others have pointed out mixing finances and family is not a good idea, it changes your relationship from parent - child to lender - borrower.

Another disadvantage if you are carrying the loan, would you be able to report that to the credit agencies so it shows up and helps you child's credit rating?
All good points. I started and ended on the "selling home to child". There is a small chance of something good happening and A LOT of chances of bad will. All I know is there is NO WAY I would ever let my parents or in laws have some financial power over me and my family. That is a recipe for disaster.

Good luck.
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Re: On selling home to a child

Post by Sandi_k »

JGoneRiding wrote: Sat Oct 21, 2017 4:56 pm Why involve a real estate agent? I believe CA is like WA in that title companies are the standard. They do all the real work. Simply submit a signed purchase agreement to them. And they will make sure everything is checked and recorded. All a real estate agent does is help identify a buyer. That part is done.

I will add at least here the title companies also know which entities do loan management for owner financed deals. They handled all the paperwork for that too when I did one. The loan management company made sure that everything was recorded correctly on both ends for both collecting interest and reporting interest for deductions. It was really easy
Not entirely true. Realtors also handle all the required disclosures to the buyer - in CA, they are not trivial. Lead paint, asbestos, easements, etc.

I'd involve a lawyer.

Also, I'd only do this if there is only *one* child. If there's a sibling, it could get messy, most especially if the buyer child doesn't pay as agreed...
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RetiredMule
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Re: On selling home to a child

Post by RetiredMule »

Many thanks for the responses!

I did already consider the issue of mixing finances with close relatives, and I do know from my own past experience too that it's not a great thing to do (to be avoided if possible) -

Yes, there is a sibling involved that would definitely complicate the situation, and I'm almost ready to write off this idea just due to that consideration alone.

Great to have had the discussion, as it brings out some good thoughts my fellow BHs have had on this topic!

Thanks,
RetiredMule
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Re: On selling home to a child

Post by itstoomuch »

Retired Mule wrote:Questions:

1) Since this is a "seller financed" sale, where the parents are selling the house to the child on standard mortgage terms (reasonable interest rates, market value as the sale price, etc.), any thing else to look out for on this (assume no defaults)?

2) Other than down payment and fees involved for closing, any need for any other finance to be arranged for closing, since the loan is issued by the parents? ( i.e., the parents do not need to receive the settlement for the full sale amount from the child, except documenting the terms of the loan and down payment).

3) Any other legal/procedural/financial issues/caveats on this?

Thanks for your inputs...
We have an Only. We and Only are financially secure.
1} Reasonable interest terms? Our son (32) refi'd earlier this year at 3.4%, 30 year, 55% equity based on bank appraisal. 800 FICO. Seattle.
We (67/70) bought August 2017, at 4.75%, ~40% down, 22% over asking, appraisal OK, 750 FICO. Redmond WA.

2} Set up an escrow account. Title company will handle details.
3} Could you rent home? We decided to pass on properties to heirs on a stepup basis. Our son is already the unpaid property manager for 2 properties
YMMV
Last edited by itstoomuch on Mon Oct 23, 2017 1:00 am, edited 3 times in total.
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mouses
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Re: On selling home to a child

Post by mouses »

How does this affect property taxes? I have forgotten how that works in CA when a house goes to a kid of the owner, and if it is different for selling vs. inheriting.

I sold my house in CA using a real estate attorney. It cost me $2k or $3k about twenty years ago, The attorney was up to speed on all the disclosures required, etc. If I remember the % correctly for a real estate agent, I would have had to fork out about ten times that much. I would certainly use a real estate attorney, not a general attorney, and not expect a title company to know everything to do.
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Re: On selling home to a child

Post by littlebird »

dm200 wrote: Sat Oct 21, 2017 3:02 pm Example of "family friction": My late father offered to refinance my brother and sister-in-law's mortgage at a favorable interest rate. They took him up on the offer and my father-in-law wanted and got a lien recorded for this mortgage. It turned out that my sister-in-law was "insulted" or "hurt" by her husband's father insisting on the mortgage lien being so recorded.

At one point when she brought up this issue at some family event, I said nothing (one way or the other). [There may have been some other things going on in the family as well, but I was not involved].
Unless the mortgage is properly recorded, your brother and SIL cannot legally deduct the mortgage interest.
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