By Alexandra Romeo Boyles
Few financial milestones carry as much significance as owning a home. For many individuals, purchasing a house represents far more than just an investment in real estate; it symbolizes security, stability, independence, and growth. However, achieving the dream of home ownership is not without significant barriers to entry in today’s market environment: (1) inflation peaked at 9.1% in June of 2022; (2) the Federal Reserve’s historic hiking spree — 500 basis points of increase since March of 2022—brought rates to 20 year highs; (3) post-COVID migration patterns of the modern hybrid employee in the US have caused property prices to soar; and (4) a Presidential election at the end of this year, together with the backdrop of heightened global geopolitical uncertainty, have created a palpable “tipping point” sentiment of market uncertainty. Moreover, securing approval from a traditional mortgage lender as one starts out in life with little to no credit history and short employment tenure can be challenging. In such times, the concept of parents assisting their children with the purchase of first homes has become more important than ever.
In helping the rising generation attain homeownership, parents contribute to long-term financial security and prosperity of the broader family. Owning a home can serve as a foundation for building equity, securing future loans, and even establishing a diversified income stream through rental properties’ cash flow and / or property appreciation. Moreover, assisting children with the purchase of their first home can be used as a form of highly tax efficient multi-generational wealth transfer. Despite the myriad benefits of helping one’s children purchase homes, parents often find themselves grappling with the philosophical dilemma of “how much financial assistance to the next generation is appropriate?” It can be difficult to square the desire to give one’s children the tools they need to succeed, while also instilling within them core values of independence and self-sufficiency. Striking this balance requires thoughtful consideration of how much direct support will truly benefit a child’s long-term financial security and personal development without hindering work ethic.
One solution we’ve discussed with clients to help strike this balance is to utilize an intra-family loan strategy to deliver assistance to children while preserving their ownership of the financial liability. At a high level, a portion of G1’s assets step in to serve as G2’s mortgage lender – a concept referred to colloquially as “Bank Mom & Dad.” Essentially, a portion of the parents’ liquid portfolio is deployed to purchase a piece of real estate for the beneficial use of the next generation and in exchange for the child’s promise to repay. Unlike traditional loans from financial institutions, intra-family loans typically offer more flexible terms and lower interest rates, making them an attractive option for transactions like this. As of August 2024, the minimum long term Applicable Federal Rate (“AFR”) that a family could use for one of these arrangements is 4.52%. Not only is this rate much more competitive than what the rising generation would likely be able to qualify for using a traditional mortgage lender, it also closely mirrors the yield on the 10-year Treasury Rate at 4.25%. To that end, our team views this strategy as providing the additional benefit of standing in place of a traditional fixed income or bond holding. One drawback of this financing arrangement as compared to a traditional mortgage (assuming one’s child could qualify) is that it is administratively simpler to utilize the 1099 produced by a bank to take a § 163 deduction on the interest paid on a mortgage with each year’s tax filings than it is with private loans.
Upon implementation, we recommend that G2 be required to set up recurring monthly auto-payments to fund a separate account held in the parents’ names. This allows for progress and status to be easily reported on for review by the entire family at an agreed upon cadence. This also allows us to most closely replicate the “pseudo bond” schema for G1 since it enables our team to quickly disperse the portion of these transfers designated as principal repayments back to the parents’ investment portfolio, while distributing the interest portion back out to G1 just as would have been the result had the portfolio stayed in public fixed income holdings.
At Alpha Capital Family Office, our team plays the crucial role of intermediary between the financing parents and the beneficiary children to help preserve the transactional integrity of such a strategy. For example, it is crucial — from both a legal / compliance perspective, but also in the interest of preserving family dynamics – for both parties to formalize this type of loan agreement. The written contract must clearly spell out key terms such as total loan amount, anticipated repayment schedule, interest rate, and consequences of default. This formal approach not only clarifies expectations, but also helps preserve familial relationships by minimizing misunderstandings or disagreements that could arise from the us of more informal arrangements.
Our team can also build an amortization schedule for this type of financing that is regularly reviewed with both G1 and G2. This helps ensure that children understand the magnitude of the transaction and appreciate the comparative benefit of the intra-family loan versus a traditional mortgage. As a default, we recommend using a 30-year amortization, but the flexibility of intra-family loans allows us to customize terms like this. For example, some clients have built in balloon payments in year five to encourage their children to seek alternative sources of leverage once they’ve established financial independence and a healthy credit history. This also helps protect G1’s portfolio from long term interest rate risk.
Our team also takes seriously the responsibility of educating the rising generation of our client families, and these intra-family loans are no exception. We work with clients’ children to teach them ways to be smarter with real estate leverage through discussions around things like the “13th annual payment principle” that can essentially convert a 30-year mortgage into a 15-year facility. We also take great care at the outset of these intra-family loan discussions to ensure G2 fully understands the mechanics of shortening an amortization schedule as a way to save on the overall interest burden while also balancing important cash flow considerations. In the end, several things have been achieved using an intra-family loan to assist one’s child in purchasing his or her first home. First – and often most importantly, – the family has supported each other. Second, parents have replaced a core fixed income investment with an inflation hedged real estate investment that was likely yielding no more than this intra-family loan receivable. Third, parents have taken a meaningful step toward improving the financial literacy and independence of their children. Intra-family loans, when handled transparently and responsibly, can strengthen familial bonds while supporting financial goals of multiple generations.
Investment advisory services are offered through Alpha Capital Family Office, LLC, a Registered Investment Adviser. The views expressed represent the opinion of Alpha Capital Family Office, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Alpha Capital Family Office, LLC believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the Alpha Capital Family Office, LLC’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations.
