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Last Updated on May 22, 2022 by Chris Panteli
Ways to Buy Your Parents House
Oftentimes it makes sense for real estate to be kept in the family. In fact, in some cases, it might actually be unavoidable due to health or financial issues experienced by an elderly parent.
What is the best way to buy your parent’s house?
There are many ways to buy your parent’s house, but it’s important to be mindful of their situation. If they are in need of money, then you might want to consider a more traditional mortgage loan. If they’re not in need of money, then you might want to consider some other options. One option is that you could buy the house from them outright and then rent it back to them. You could also gift them the house or sell it back to them at a reduced cost.
If you are thinking about whether you should purchase your family home from your parents, you’re in luck! In this detailed article, we explore creative ways to buy your parent’s house. We will discuss all you need to know about this unique real estate transaction, including its risks and benefits, the financial aspects of closing the deal, and a lot more.
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- Ways to Buy Your Parents House
- Why Do People Buy Their Parents’ House?
- Is Buying Your Parents Home Actually Worth It?
- How Do You Buy A House From Your Parents?
- 5 Creative Ways to Buy Parents House
- Wrapping Up
- Ways to Buy Your Parents House
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Why Do People Buy Their Parents’ House?
Different people have different reasons to buy a home from their parents. Here are the most common reasons to make the purchase:
Is Buying Your Parents Home Actually Worth It?
Before you decide to purchase your parents’ house, you need to look at the risks and benefits of this decision. Only when you weigh out the pros and cons will you be able to determine if it’s a good idea or a transaction you should steer clear of.
Pros of Buying Your Parent’s Home
There are several benefits of purchasing a home from a parent.
Firstly, you are in a unique position to have first-hand knowledge of the maintenance, improvements, and upkeep completed on the home. Secondly, you get to live in a home you are familiar with – one associated hopefully with countless happy and blissful memories.
Plus, your mom and dad will know that the home they’ve cherished for so long is going to stay in the family instead of being sold off to a complete stranger. They will get to revisit that home and take comfort in knowing you’re enjoying it.
But that’s not all! Here are some more benefits of buying your mom and dad’s house:
Cons of Buying Your Parent’s Home
There are plenty of benefits to purchasing a house from your parents. However, that doesn’t guarantee that a real estate transaction between you and your parents will go smoothly. For example, it might be challenging to renovate the place, knowing that your change will alter custom features or designs your parents enjoyed.
Purchasing your parents’ home is a great way to financially support your parents and keep your family home in your family.
But don’t buy just to ease your mom and dad out of a financially troubling situation or because of a sense of filial responsibility. Rather, you should want to buy their house.
How Do You Buy A House From Your Parents?
So, you have decided that you want to purchase your parent’s house. Now, what’s the next step? There are plenty of methods to purchase a house from your parents. Age-old, conventional methods and latest, less traditional routes that you could possibly take.
All strategies are risky but worthwhile if you opt to go down this path.
Along with the financial aspects, the other important consideration in purchasing a house from your parents is clear communication. It’s necessary that the purchase of the property is entirely transparent and follows the legal rules very strictly.
This helps to ensure that no one is accused of fraud or manipulation later. Having a mediator or third party, like a real estate agent, is crucial for property transactions that happen within families.
Think of How You Will Finance the Deal
First things first – think of how you are going to finance the deal. Are you going to get a loan or take out a mortgage from a bank or another financial institution? Also, think of the size of the deposit you bring to the table? Lastly, you also need to determine if you will take the seller-financed route, where your parents act as guarantors of the financial aspects of the transaction.
Make sure to keep an eye out for Inheritance Tax and Stamp Duty if you’re based in the UK or Gift Tax if you live in the US.
Again, you need to get sound legal advice on this matter. Otherwise, you could find yourself in the middle of a repossession ordeal in the future.
5 Creative Ways to Buy Parents House
Of course, you can purchase the home from your parents as you would from any other seller.
However, as you’re dealing with family, it’s imperative to take additional steps to ensure everyone is on the same page. Plus, you also need to make sure that it’s a fair deal for everyone!
1. Conventional Mortgaged Home Purchase
You might wish to buy your parents’ house to reside with them. Or you might want them to reside without you or for you to reside once they have moved out.
For a straightforward and formal purchase where you apply for a mortgage and have decided on a market-standard price for your house, these steps outline the typical process.
➡️Step #1 – Get Pre-Approved for Mortgage
The first thing you need to do when purchasing a house from your parents is going to a bank or lender to get a pre-approval. In the pre-approval process, the lender is going to review your assets, debts, credit score, and income to tell you how much they’re willing to offer you in a loan. This way, you will have a clear idea of how much money you can afford to spend on a house.
➡️Step #2 – Determine a Purchase Price
Next, it’s necessary to come up with a purchase price for the house. Technically, a house is worth what a seller and buyer agree to in writing. Nevertheless, the idea of a “fair market value” is often subjective. You might hope to purchase the house at a lower price than what the house would fetch on the open market. However, your parents might want to sell it at fair market value because they want the money for retirement.
The good news is there are ways to find a middle ground. For example, you can:
- Get a comparative market analysis (CMA). A real estate agent can access local databases of houses sold to give you an estimate of the actual worth of your parent’s house.
- Use online valuation tools. An online property value estimating tool might give you a general idea of house sales. However, the data might not be as accurate as a CMA.
- Get a property appraisal. A property appraisal is a report that a licensed real estate appraiser generated to give you an objective idea of your house’s value based on an in-depth comparison of the house’s features to other houses sold in your area. Keep in mind that if you need a mortgage to purchase the property, the lender will perhaps need an appraisal to approve the loan.
💡Important Tip: It’s best to get a home inspection done before buying any house to learn about issues that might not be obvious at first. The goal of a home inspection is to give you a comprehensive look at all the areas of the house. If your parents are disabled or old, they might not have performed ongoing maintenance. Thus, it’s even more important for you to know what’s happening from the foundation of the house right up to the roof.
➡️Step #3 – Decide if You Need Legal Representation
Your mom and dad might not hire a real estate agent to save on the commission costs. This means you won’t get the guidance a real estate professional can provide to correctly prepare the paperwork and understand the legal consequences if things go wrong.
If you don’t work with a real estate agent, you should ask an attorney to draft a contract for you. You might also have to speak to a tax advisor if your parents are gifting you equity or money for the down payment.
➡️Step #4 – Sign the Contract or Purchase Agreement
When it comes to property transactions, even a deal between you and your parents has to be in writing. This way, it will be legally binding. Here is what you will have to do to make that happen:
- Ask a real estate professional to draft a purchase agreement. An experienced real estate professional has the expertise to negotiate contracts depending on your state’s laws. They can help you determine which party should pay which fees. Moreover, real estate professionals usually know the selling prices of houses. Hence, they can help you negotiate a price based on existing market trends.
- Get an attorney or escrow officer to prepare “escrow instructions.” If you arent hiring a real estate professional, you still need to have escrow instructions. This includes details about the price, who will bear which costs, and if the purchase involves you receiving a gift or mortgage from your parents to make the down payment.
An escrow officer or real estate attorney can prepare the documents for you in exchange for a fee. They also act as an unbiased third party that manages all the accounting of the money that flows through the transaction. Generally, the purchase contract should include:
- The price of the house
- Names of the seller and buyer
- Who will pay which closing costs?
- Anything that will go or stay with the property (like fixtures, built-in shelves, and personal property)
- The closing date.
➡️Step #5 – Document Any Gifts of Equity for Purchasing Your Parents’ House
In several cases, an older person will select a gift of equity to assist their child bypass a down payment. Usually, cash isn’t involved. Rather, the parents just gift a dollar amount of the equity towards the down payment. Keep in mind that the rules for a gift of equity are different than conventional cash down payment gift rules.
FHA Gift of Equity Rules
Many first-time homebuyers prefer taking loans backed by the Federal Housing Administration (FHA). This is due to their flexible qualifying standard as compared to those of traditional loans. You might get approval even if you have a credit score of 500 with a 10% down payment. FHA loans might also be approved if your debt is higher than your income. To get a gift of equity for just the minimum down payment of 3.5%, you will need to meet one of the following requirements:
- Prove the house was your parents’ principal residence
- Verify you were residing in the house as your principal residence as a tenant with a copy of the lease and documentation of six months’ worth of rent payments.
If you cannot meet the above conditions, the following conditions for the gift of equity will apply:
- You will require a 15% gift of equity
- You have to show a gift letter proving the equity is a gift and that you don’t have to make any repayment.
➡️Step #6 – Apply for a Mortgage and Go Through the Underwriting Process
In case you don’t have the cash to pay for a house, you will have to apply for a home loan. Don’t forget to inform your lender that you are purchasing a home from your parents as it’s viewed as a “non-arm’s length” transaction. The idea of “arm’s length” is to make sure both the parties are working in their personal interest.
After you have applied for the mortgage, you move on to the underwriting process. Here, the lender will meticulously review your finances to ensure that you are eligible for a loan and capable of making your mortgage payments. You will likely have to provide several financial documents, including:
- Social security number and ID
- Pay stubs from the past 30 days
- I-9s or W-2s from the past two years
- Federal tax return statements
- Proof of any other income sources and assets
- Details on long-term debts like a car or student loan
- Recent bank statements
- Credit card statements
➡️Step #7 – Consider a Seller Carryback if You Don’t Get a Mortgage
If your mortgage application gets rejected, your parents might be open to considering what’s known as a “seller carryback.” Here, you won’t get a home loan from a mortgage lender or your bank. Rather, your parents can act as the bank, and you can pay them for a set period until you sort out your finances.
A note is generally recorded, and a lien is placed on the home that has to be paid off in case you decide to sell the house.
➡️Step #8 – Close the Sale
Once your loan is approved, your lender will either send you to a notary or set up a meeting with their title company to help close the sale. It can be at a title company or bank or with a real estate attorney.
Before signing the documents, make sure to read all the terms carefully. Check if the figures that are written down – like the mortgage payment, sales price, and closing costs – match what was outlined for you when you got your loan estimate.
If you’re taking out a mortgage, you will get a closing disclosure three business days before the closing. You can make any required amendments before signing the paperwork.
Of course, if you buy the house at full market value, your parents won’t incur any extra gift tax. Thus, the property sale is treated the same as any other.
You even benefit from saving costs on agents and fees.
2. Rent Out the House to Your Parents
In case your parents cannot afford to keep their existing home, one way to financially support them is to become their landlord.
If they are facing any financial troubles, you might want to purchase your parents’ house and rent it back to them. This way, you won’t just benefit from an additional income but stay assured knowing that you have trustworthy and reliable long-term tenants.
Again, you need to make sure that you have taken proper legal advice. This is particularly important if you wish to rent the house to them at a below-market rental price.
You will have to announce your intent during the buying process because certain lenders won’t cater to this arrangement.
It can even have tax implications. However, US law does allow landlords to lower the rent charged to family members by a maximum of 20% of the market value.
Keep in mind that investment property loans in the US or buy-to-let mortgages in the UK come with higher fees and interest rates than conventional mortgages. Thus, make sure to include the extra costs into your purchase decisions.
Another benefit of this route is that it puts instant cash in your parents’ pockets without considering a reverse mortgage. Many times, a reverse mortgage doesn’t allow for a death benefit, and upon the parent’s demise, the family learns that the home is now possessed by the bank.
3. Gift of Equity on the House
If you don’t have money to make a down payment for the house, certain lenders allow parents to give an “equity gift” to relatives. Equity is the difference between the value of the house and the amount owed on the home.
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A gift of equity means your parents give you all, or a percentage of, the equity they have in the home. The mortgage lender or bank allows you to use it in addition to or instead of some cash down payment. This requires specific paperwork.
You will still need to apply for the mortgage and go through the underwriting process to meet the requirements of the lenders. This includes pulling your credit history and credit score.
Bear in mind, depending on individual circumstances, using a gift of equity can have tax and other financial consequences. Ideally, you should speak to a tax advisor for more clarity on this.
4. Life Estate
A life estate is where there are two joint legal owners of a property. In this case, the joint owners are the parents and children.
The parents usually retain possession of the house until their death. After their demise, the adult child takes over the possession of the property.
One major benefit of a life estate is that, at the time of the parent’s death, the house will not go through probate. Rather, it will be transferred directly to the second homeowner (in this case, the child).
Nevertheless, this can differ from one case to another. Plus, you need to be well-versed with your country’s laws before drafting a life estate agreement.
Purchasing your family home and renting it to your mom and dad is a little risky. What would happen if you died before your parents?
Drafting a life estate agreement removes this risk. It secures your mom and dad and affirms that they can live in the house until their demise, irrespective of who owns the house next.
A life estate does have its own drawbacks too. For instance, even though the property doesn’t go through probate, it’s still subject to property tax and estate taxes, based on the value. You can speak to a financial advisor for estate planning advice.
5. Purchase A Second Home
This method is a little different from the strategies listed above. However, if you want to buy a new house for your mom and dad to reside in, instead of buying your parents’ existing home, the best thing might be for you to buy a second home and have them live in the new house.
The soaring property prices might make it difficult for your parents to buy a new house. Thus, you might want to use this strategy because your mom and dad are in financial trouble, or you want them to live closer to you.
If you are earning well and have considerable assets, this could be a wise move that proves beneficial for both you and your parents.
However, you need to make sure that you can afford a mortgage on a second home. And for that, you need to know how a mortgage for a second home actually works. You also need to know how you want to list the property on the home loan. Is it an investment property or a second home? There are several differences that can impact your taxes and loan rates.
Second-home mortgage interest rates and upfront costs are typically higher than conventional mortgages. Moreover, you might have to make a bigger down payment and have a higher income to offset the increased risk borne by lenders.
You might qualify for your first mortgage even if you have a very low credit score, like 580. But you will need a better credit score to secure a mortgage on a second home.
Another way to purchase a second home is to use a home equity loan on your primary home for a cash-out refinance that will possibly give you a lower interest rate than another mortgage would.
If you plan to take out a mortgage to purchase a second home, you will have to list it with the bank as an investment property or a second home if you don’t plan on using it as a primary home. A loan for a second home, also known as a vacation home, has lender rules in a conforming mortgage that it has to be at least 50 miles from your primary residence.
Whichever method you choose, make sure you do everything correctly and follow the required steps.
Even though you are purchasing from your immediate family, you still need to ensure everything is done legally. After all, purchasing a house is a legal arrangement too.
Plus, do get every detail and agreement in written form. This secures you and your parents if any issues come up in the future.
Doing your homework wisely and thoroughly is crucial before you decide on any of the methods listed above. Discuss everything in-depth with your parents and siblings or other family members who might be affected by the purchase. Make sure you have everything decided and documented legally.
After you have finalized your decision, select one of the methods to purchase your parents’ house mentioned here. Get astute legal advice pertinent to your country or state of residence, and go ahead!