Author Topic: Equity as a Down Payment? Any advice/warnings?  (Read 812 times)

artemidorus

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Equity as a Down Payment? Any advice/warnings?
« on: May 20, 2019, 10:57:08 AM »
My sibling often comes to me for help on financial matters, but this is out of my wheelhouse and I wanted to see if the wisdom of this community could point me in the direction of resources quickly. Google is a mess of tainted advice.

Very long story short on a quickly moving series of events - an INCREDIBLY generous couple wants to sell their home to my sibling at an enormous discount. They're asking for maybe 10% of what they could get on the open market, and they know this. My sibling is able to swing a 20% down payment at this price point, but will basically exhaust cash reserves. Their credit union is pitching them on using the equity of the house for a down payment. If it were market value, it would be out of their price range, but not so drastically that they can't manage the annual property taxes.

My sibling and his spouse have a set of large student loan totals and a young child as factors affecting their decisions, currently renting on a month-to-month lease. They are not strictly Mustachian and not making 6-figure salaries, just a family of three that have been slowly making solid decisions to get their finances in order and lower their debt/stress levels. The allure of whatever decision they make enabling them to wipe out relatively high-interest student loans (close to 8% on some) is very appealing.

  • Tax implications to using equity as a down payment? I have to imagine there is some, I just don't know where to start with calculating this.
  • Is there a mortgage option a Mustachian would recommend over others? Before this option came up, I was telling them to to ask about 15 year mortgages instead of 30, on the basis of being debt free before their child goes to college.
  • Is there something else I'm overlooking here? I'm not a real estate person, feel free to talk down to me like I'm a dummy.
  • Is this already covered somewhere? Surprise surprise, any search with "Equity" within the forums is not helpful.

Any wisdom on where I could digest more info on situations like this without reading an entire book on mortgage options would be so appreciated!

sisto

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #1 on: May 20, 2019, 11:45:01 AM »
I can't even pretend to offer much help on this except that I think you need to list what state it's in for the tax calculations. That is likely the most important factor in trying to calculate the best option. Do they know what mortgage rate they can get, probably also useful.

artemidorus

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #2 on: May 20, 2019, 11:57:52 AM »
State is Massachusetts.

Having a conversation a little later around the rates being offered, although my guess is not the most favorable. They went to the bank for a pre-approval a couple years ago and were denied - as it was relayed to me, their debt-to-income ratio was going to prevent them from getting any mortgage. Because of that, they hadn't even been looking at real estate until this option came up.

Jon Bon

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #3 on: May 20, 2019, 12:00:48 PM »
First thing I need to know.

The generous couple is offering a 10% discount, or a 90% discount? If it is a 1 million dollar house selling for 900k, fine. If it is selling for 100k but FMV is 1 million? WTF?

They still cant swing the down-payment on a house being sold at a 90% discount, uh they should not be buying a house at all! Furthermore if I am reading this right they are trying to tap the equity in a house they dont currently own?

Lastly they are gonna have to pay a metric shit-ton of taxes on this. Any discount on a house will be subject to taxation.  I would not recommend lying about this/trying to hide it etc.

If they can only afford to pay 10% of the price of the house, how are they going to afford the taxes, insurance, upkeep, gas, electric etc?  There is a lot more I want to share on this subject but I need clarification on the above points. This one is breaking my brain a little bit. We can get into 15/30 and D/I ratios later.


artemidorus

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #4 on: May 20, 2019, 01:35:17 PM »
Correct, this generous couple is offering about a 90% discount. I know, I also had many many questions on the why and how. It's pretty much like winning a lottery, just for a house.

They are able to swing the down payment, it's now just a matter of how best to structure the mortgage. And you're reading correctly, the credit union put the option on the table that because of the discrepancy between their potential mortgage and the FMV of the house, they could tap the equity in the house they don't currently own, and hold onto their cash they planned to use for a down payment. This was news to me, and my general tendency to assume that something will bite them in the ass.

They'll be willing to take the tax hit, although they certainly have to figure out now just what that will be and brace for it. Their prior plan had been (correctly) to continue renting in an affordable area, and save for potentially buying years from now. They were not actively house shopping, this home is never hitting the market.

They're obviously talking to various professionals about what all these things mean. But as we all know, most people in the real world will sell you on lots of options that are not always in your best interest. Hence my scramble to figure out what questions I should be asking, because my brain is also breaking.

Jon Bon

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #5 on: May 20, 2019, 02:37:02 PM »
Well Alrighty Then!

Give us the numbers that would help bring it out of the abstract.

The loan, I would go 30 years for sure. Its very easy to simply make a 30 year a 15 year just by paying a little more every month. Lets you pay the loan off much quicker if you want but you are not locked into a higher payment if life events happen.

Also their D/I ratio might be a factor here. Basically your monthly debt payments cannot be more then 43% of your income. So student loans, car payments, mortgage etc would all get added in.

I'm not qualified on the taxes here, but they might be able to lighten the blow based on some light googling. But IMO this would be the biggest issue here by far. If they are on the hook for a 500k gift that tax could be impossible. Like do I want to live in a 5 million dollar house if I have to pay $1 million in taxes? No, I do not.
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I am sure they could get a loan on their house. Assuming they are sitting on 90% equity day one. It might be wise for them to wait a year to 18 months to pull that trigger. Banks can get jumpy on too many large credit moves in too short of time.

YMMV - sounds like a lot of information is (intentionally) missing, so take it with a brick of salt. 




srad

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #6 on: May 20, 2019, 03:26:56 PM »
What is the value of the house?  This will help us asses the tax implications it more accurately.

But a few thoughts, If this is true and they are being offered a home for 10% of the market value. Their main goal right now needs to be how do they acquire this house.  I'd want to see their kitchen blender, Pokemon cards, baby stroller and dads Xbox on craigslist right now.

You said they have the down payment money, I don't know how much they can afford but i always recommend a 30 year fixed.  But in this case only,  if a 30 year fixed is stretching them, i'd say get a 7 year interest only loan, or whatever loan gives them the most affordable payment.   Since they will never be upside down on this house, they can always refi to a 30 fixed when they are a little more flush, or sell...

After they buy it yes, they can borrow more money from it, they have a ton of equity, banks like equity.

Tax implications on using equity, none its a loan, you don't pay taxes on loans.
Tax implications when they sell, only on the amount more than 500k profit.   And if i ever sell a property where i make more than 500k, i'd happily hand deliver my check to the IRS in my new (ok lightly used) Bentley.

As for the gift tax mentioned, no idea.  i know my grandparents inherited a home from their neighbor, they didn't pay a tax on it (and this home is in the heart of silicon valley).  Is inheritance the same as a gift?

theoverlook

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #7 on: May 20, 2019, 03:33:42 PM »
Federal gift taxes are paid by the giver, not the receiver. And the giver only pays those taxes if they choose to - they can use some of their lifetime exemption up on the gift tax return. I wonder though if there would even be any gift involved if their basis is less than 10% of the value of the house. I don't know - just wondering.

You absolutely can use a loan against the equity of the house in purchasing it. I have done so before when wanting to keep cash free - I put 10% down, 10% home equity line, and 80% traditional mortgage, so no PMI and interest was minimal on the home equity line. I wouldn't hesitate to do that in this situation. Assuming the house is in good condition, fits their needs, and is in area they want to live in, the most important question from there is how do they make it work. Just DO IT.

dandarc

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #8 on: May 20, 2019, 03:42:09 PM »
Is there any kind of pre-existing relationship with the sellers? I'd think that unless the sellers are your sibling's employer, or there was some kind of written agreement for services or a business deal of some kind attached to this, that this huge discount would be a considered a gift for tax purposes.

If it is a gift, then any gift tax is owed by the giver, so that shouldn't be an issue for your sibling, unless there is some agreement with the sellers around compensating for that.

Really, if they are financially responsible people, they should take as much of a loan as the bank or credit union will give them at a good, fixed interest rate. Also taking into account their cash-flow level of comfort. Invest whatever doesn't get paid to the sellers. Certainly no reason for the buyer's to bring any cash to the closing - LTV will look great even with 0 down and a substantial amount of cash-out.

SwordGuy

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #9 on: May 20, 2019, 05:13:13 PM »
Is the house in good enough shape to turn around and sell at 80-100% of fair market value?

Because if it is, they can definitely afford to buy and then sell it.

Might cause a rift with the couple, of course, so there's that.

artemidorus

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #10 on: May 20, 2019, 07:58:29 PM »
Thank you all - this is great and very reassuring to hear from this forum! Glad I hear this isnít a terrible option, and the chiming Iím on taxes is much more clear now.

The home has an assessed value of just over $500K and Zillow puts it even higher. The sellers opening price they asked for was under $100K. My sibling safely has 20% of that in cash, but not enough to buy it outright. It is a home in a community they already live in, so they like the neighborhood. Itís 20 minutes from downtown Boston, so take that for what you will on the value. The land alone is worth chasing this offer down. And itís two more bedrooms than they need right now.

No business relationship. It sounds like this couple had something similar happen when they bought it many years ago, and theyíre just good people that believe in paying it forward to a young family. My sibling is a lucky recipient, but you can imagine why it all feels too good to be true and I wanted to do some due diligence for them.

They could certainly flip the home, it sounds outdated and could use some modernizing, but by no means dilapidated. But they have no interest in selling it. I think they just see it as a great opportunity, take it as a sign and live their lives in this house so they can figure out everything else with less stress.

Thanks all for the help; this is invaluable!

lhamo

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #11 on: May 20, 2019, 08:05:37 PM »
I would be very cautious and make sure the giving couple has no heirs.  Because if they do I could see this resulting in a long, protracted lawsuit from the people who are essentially being disinherited. It is the giving couple's right to do what they want with their assets, but it is easy for the disgruntled to claim they were somehow manipulated or swindled, and there is enough assets at stake to make a lawsuit worthwhile to some people.

Cassie

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #12 on: May 20, 2019, 08:34:24 PM »
I would use their cash for the down payment and take a 30 year mortgage. They can rebuild their savings. 

tralfamadorian

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #13 on: May 26, 2019, 07:31:49 AM »
If theyíre comfortable with the payments, thereís no reason not to take the credit unionís offer of no down payment. With 20% LTV itís easy to see how the credit union would be interested. Also, some repairs will most probably come up after closing and it would be more financially prudent for them to have those savings on hand. It also would be more conservative to do the 30 year. If they financially knock it out of the park and have the $xxk to pay it off in the future, thatís fine.

As others have mentioned, there would be no taxes for your relatives.

dandarc

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #14 on: May 26, 2019, 09:49:10 AM »
If theyíre comfortable with the payments, thereís no reason not to take the credit unionís offer of no down payment. With 20% LTV itís easy to see how the credit union would be interested. Also, some repairs will most probably come up after closing and it would be more financially prudent for them to have those savings on hand. It also would be more conservative to do the 30 year. If they financially knock it out of the park and have the $xxk to pay it off in the future, thatís fine.

As others have mentioned, there would be no taxes for your relatives.
Assuming good, responsible financial habits, why not take say 50% and invest the extra 30%? Or even 70-80% if the credit union is willing and they have sufficient cash flow for the payment to not hurt too much. #longliveBoarder42!

tralfamadorian

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Re: Equity as a Down Payment? Any advice/warnings?
« Reply #15 on: May 26, 2019, 11:15:03 AM »
If theyíre comfortable with the payments, thereís no reason not to take the credit unionís offer of no down payment. With 20% LTV itís easy to see how the credit union would be interested. Also, some repairs will most probably come up after closing and it would be more financially prudent for them to have those savings on hand. It also would be more conservative to do the 30 year. If they financially knock it out of the park and have the $xxk to pay it off in the future, thatís fine.

As others have mentioned, there would be no taxes for your relatives.
Assuming good, responsible financial habits, why not take say 50% and invest the extra 30%? Or even 70-80% if the credit union is willing and they have sufficient cash flow for the payment to not hurt too much. #longliveBoarder42!

Of course we as mustachians would be all over that. Hell, I would take the extra 65-70% LTV and invest in a few/several rentals in a LCOL growing southern/midwest city whose profit would cover the PITI to bring the housing slice of the expenses pie to ~$0.

However, since the OP mentioned that their relatives were unable to get pre-approved for a mortgage because of a high DTI in the past, I'm presuming their finances are not MMM ideal and instead went the lowest risk, most conservative route for a recommendation.