If you are an active reader of this website, chances you are a savvy, informed investor. As we approach retirement age, smart investors have learned to reallocate their portfolio, moving away from more aggressive investments and into safer bets. Some of us have our homes paid off; some took advantage of recent years’ low mortgage rates and have refinanced to fund once-in-a-life-time vacations, pay off credit card debts, or to finally pursue that dream hobby – maybe a boat, an antique car – that could be a bit impractical, but what the heck, you’ve earned it.
Some of us are also refinancing to help our children. We tell them we all had it tougher when we were their age; but truth be told, in today’s economy, young people do have a lot of financial burdens. Average student loan debt has doubled in just twelve years. Starting salaries are in much better shape than a decade ago, but current level of wage growth cannot keep up with home price growth, which is now at 6.2% annual increase nationally and as high as 13% in markets such as Seattle. If you have adult children living in one of these expensive cities, a conversation about helping them buy a home may already be familiar to you.
To many, parents helping a child buy a home is a duty and a rite of passage. Nearly 1 in 4 (23%) of all home loans in the U.S. now has a non-spouse co-borrower listed for the mortgage. In most cases, it is a parent who is co-signing. In San Jose, that figure is 51%; in Miami, 45%; in Seattle, 39% of home loans now have a non-spouse co-borrower. So it is certainly common particularly in expensive housing markets for a parent to be a co-borrower of an adult child’s home loan.
Beyond that, parents are also helping to fund children’s down payment. According to ValueInsured’s latest quarterly Modern Homebuyer Survey, 34% of Millennial first-time homebuyers plan to rely on a parent’s help to fund their home down payment. In Denver where home prices are giving Seattle a run for its money, 41% of young people said they need to rely on their parents with their down payment. 46% of Baby Boomers nationally report they have helped or plan to help their children with a down payment, and again, that percentage is higher in hot housing markets.
No doubt many among us are refinancing our own home to help our children. Some might be able to draw funds from savings or other investments to help without a cash-out refinance. In either scenario, The assumption is that home prices will continue to go up, and eventually, hopefully, the adult child will be in a position to pay back the parent. Or if it is a gift, the down payment would give the child a leg up for a better financial future as home values rise. Sounds great, but all relies on a big “if”…
Any housing historian or economist would tell you home prices do tend to go up long term, but never in a straight ascending line. The housing market on average goes through 7-10 year value fluctuation cycles. As luck would have it, we are now right at the 10-year mark from the height – and the eventual spectacular collapse – of the last cycle that ended in 2008. As parents, we want to help our children and set them up for success, but we need to be careful that by helping, we are not moving them closer to the eye of the next financial storm.
After nearly a decade of downward trends, interest rates are now on an upward trajectory, with 30-year fixed now at a 4-year high. Home sales volume are on a decline, indicating that while some people are willing to pay the possibly overvalued prices, many more are staying on the sidelines to avoid buying high, and therefore bringing down total home sales volume.
The Federal Reserve is planning another three to four interest rate hikes this year. Median home prices are now 20 to 30 percent above pre-bubble peak of the last housing correction in many overheated markets. Housing bubble talks are getting more rampant, including by renowned money manager James Stack, who predicted the last one. Some say like the stock market, home prices could continue to go up. But we are witnessing more volatility after several years of uninterrupted gains on Wall Street. Now, even typically bullish Goldman Sachs is warning there is a "high probability" for a stock market correction in the coming months.
If you have or plan to refinance your own home to help your child buy a home, it is prudent to bear in mind that young people who buy now could be buying at top of the market. If the housing market corrects and your child needs to move for a job or other reasons during the downturn – as mobile young families often do – one home purchase by your child now could have regrettable effects later on two households. Nearly half of the country’s housing markets – including Chicago, Miami and Las Vegas – still have not recovered close to their pre-2008 crash peaks. In other words, a parent who refinanced their own home to help a child buy a home in Chicago in 2006 could still be under-water, in both households.
Unlike during the last housing peak, the current market run-up does come with new solutions: Down Payment Protection and Equity Protection. These innovative and consumer empowering products are insurance policies that can be purchased by homebuyers and refinance mortgage borrowers from their insurance agents to protect their down payment and appraised home equity value. Even if homebuyers are buying at peak of the market, if they sell later at a loss after a correction, their loss in the down payment they put into the home purchase is reimbursed back to them, in a simple, no-catch process that issues them a check of the loss value within 30 days. Refinance borrowers have a similar option, in equity protection. They can lock in the appraised value of their home at market high when they refinance; when they sell later at a loss after a downturn, their loss in equity can be reimbursed back to them, also simply and quickly within 30 days.
Caring parents want to help their adult children pursue the American Dream of homeownership and build their own nest. It’s an admirable thing to do. But there’s a smart way to do it without exposure to unpredictable market risks, while setting your children up for more secure leaps into their financial future. In the same way you may be reallocating your own investment to safer money places, there is now a safer way to buy a home, and certainly a safer, smarter way to be a generous parent.