Should You Give Your Kids a Mortgage?

A few years ago, uncomfortable with volatility in the stock market, Maryland couple Gail and David Boesel decided to liquidate a sizable share of their portfolio.

The semiretired consultants took some of the money and invested in real estate. "Then we looked at our other cash and looked for income," Gail Boesel said. Because of low interest rates, she added, "there was no income to be had." So the couple did something unusual: They let their grown kids know that if they were interested in a parent-held mortgage that was a percentage point below market — at that time 3.5 percent — they'd provide it.

Two of their kids took them up on it. "For us, this was a no-brainer," Gail said.

A number of people seem to agree with the Boesels. According to the National Association of Realtors, one-third of first-time buyers received a gift or loan from their families to help buy a home in 2011. And there are times it makes sense.

Perhaps you're sitting on cash earning you next to nothing. Perhaps your offspring are earning enough to make monthly payments toward a house but don't have the credit (or down payment) necessary to qualify on their own. Or perhaps, like the Boesels, your kids have decent credit and already have a mortgage, but you can offer what is effectively a refinance, at better financial terms.

But that doesn't mean you should go into it without your eyes open. "Every family needs to assess whether this is the right type of investment decision for them," says Timothy Burke, CEO of National Family Mortgage, which specializes in these transactions. Here's what you need to know.

You don't have to go all in

Although some families have the ability to lend the full amount, most of Burke's customers are making down payment loans. "Many parents are making loans of about $50,000 to help their children qualify for mortgages from other lenders," he says. The key is to structure these loans properly. That means:

Obey IRS rules

If you want to do this for your children, you'll want to properly structure, document and register the transaction to be in compliance with the tax code. Although anyone can make an annual gift of up to $14,000 to any other individual, for loans of more than $10,000 the IRS mandates that the lender must earn interest at or above a rate set by the IRS — currently around 2.5 percent for loans of more than nine years. These rates change monthly and are generally around a point or point and a half below average.

In order for your children to claim the mortgage interest deduction, the mortgage must be registered. That's where companies like National Family Mortgage come into play, though real estate attorneys often do this work as well. They'll prepare a promissory or mortgage note that sets out the terms, interest rate, payment dates and frequency. These notes are legally binding.