Father and son looking out a window

The median sales price of a home is now $305,000, the real estate website Redfin recently reported. At that price, coming up with a down payment is no easy feat.

It's no surprise, then, that the road to owning a home is getting rockier. That's especially true for younger buyers. Homeownership by people in their 20s and 30s is at a three-decade low of 19 percent, compared with 28 percent in 1988, Census Bureau data show [PDF].

Student-loan debt is partly to blame, as are tight housing markets in many parts of the country and rising mortgage rates.

Nonetheless, mortgage rates are still historically low—around 4.5 percent for a 30-year, fixed-rate loan, according to Bankrate. If you can give an adult child down-payment assistance, you could help him or her own a home rather than having to rent.

But know the rules before you offer any down-payment assistance.

Check Out Low Down-Payment Options

First, make sure your relative has looked into programs that let her put down less than the traditional 10 to 20 percent. Fannie Mae and Freddie Mac, the quasi-government entities that underwrite at least half of the country’s mortgages, offer mortgages that require just 3 percent down, a reduction from the 5 percent down often required for standard mortgages.

Making a small down payment, though, has drawbacks. Until your relative's home equity reaches 20 percent, she will need to pay mortgage insurance—at an annual cost of usually 0.5 to 1 percent of the loan’s value.

Payment is made monthly, which compensates the lender in the event of a default. (FHA mortgages require mortgage insurance for the duration of the loan.) Because the buyer is putting down less, she will also face larger monthly payments. In contrast, a large down payment can make buyers more attractive to sellers.

Make a Gift the Right Way

Gifting is preferable to lending when offering down-payment assistance, says Bob Harkson, chief financial planner at Phase 2 Wealth Advisors in Gig Harbor, Wash. It's "cleaner" than a loan and can lead to fewer problems with mortgage lenders and the IRS, he explains.

But you'll need to document that it's really a gift. Otherwise, a lender reviewing your child's bank statements may construe a large, recent deposit as a loan. A mortgage officer could take into account the estimated monthly repayments for that loan when determining how big a mortgage to lend.

"Lenders are astute," Harkson says. "They watch the cash flow."

The solution: Provide the lender with a signed letter stating that the money is indeed a gift.

"That's if you're going to be ethical and legal about it," Harkson adds. "I’ve seen people 'gift' money and actually require their kids pay it back. But technically, you’re not supposed to do that."

Be Aware of Other Gifting Considerations

Think carefully about who you gift your money to.

"Not every parent is comfortable giving gifts to a child-in-law," notes Emily Sanders, a CPA and managing director of the Atlanta office of United Capital, a wealth management company.

There also are tax consequences to gifting, though they affect few people. You can gift up to $15,000 to an unlimited number of people in 2018 and not have to pay the federal gift tax of up to 40 percent.

Parents filing taxes jointly could each give a son and daughter-in-law $15,000. That’s $30,000 per person, or $60,000 total.

Another strategy to avoid paying tax is to make one gift of up to $15,000 in December and another one in January, says Mary Clements Pajak, a trust and estates attorney based in Newton, Mass. 

Use IRA Funds Sparingly

Anyone wanting to help with a down payment can withdraw $10,000 penalty-free from an IRA to fund qualified costs related to the purchase of a relative's first home. Those costs include expenses such as closing, finance, and settlement costs.

More on Mortgages and Home Buying

Each member of a couple could receive $10,000; in theory, a mother and father could give a daughter and son-in-law a total of $40,000 this way. (If you're older than 59 1/2, your withdrawals—known officially as distributions—are not subject to that 10-percent penalty regardless of how the money is used.)

IRA distributions must be used for a first-home purchase within 120 days of when the money is withdrawn. If the distribution originates from a traditional IRA, you'll have to pay ordinary income tax on it.

But unless you're sure you won’t need the money, it’s better to leave it invested and growing in the IRA. Take the money from another source.

"I always recommend the parents make sure they’re providing for their own retirement before they think about their kids," Harkson says. "Consider your ability to pay the tax and your overall big picture."

Lend With Caution

In spite of their drawbacks, direct loans toward down-payment assistance can benefit both sides financially if done correctly.

If you lend your child money at, say, a 3.5 percent interest rate, you’ll get a return exceeding the estimated 2.7 to 3.1 percent that a large, diversified fixed-income fund currently yields. Your child would get an interest rate lower than the national average of around 4.5 percent that banks are now offering for 30-year fixed mortgages. 

What’s more, so-called intrafamily loans usually don’t have loan-origination fees, points, mortgage insurance, or other lender costs. And families can arrange for flexible repayment schedules.

Keep in mind, though, that you would have to claim the interest portion of the mortgage payments paid to you as income on your tax returns. 

Be sure to craft the deal carefully to avoid IRS scrutiny—and family acrimony. For any loan higher than $15,000 not to be construed as a gift, the interest rate must be at least as high as the IRS monthly Applicable Federal Rate (AFR), currently about 3 percent for long-term loans. You can find the AFR easily at National Family Mortgage, a service that helps create intrafamily loans.

Have an attorney draft a detailed promissory note and record it properly under state and local laws. That way, your child can claim a mortgage interest deduction, assuming itemizing is still worthwhile under the new tax law. 

Avoid a Family Flare-Up

Before you draft the loan paperwork, make sure all interested parties communicate fully, stresses ReKeithen Miller, a certified financial planner at Palisades Hudson Financial Group in Atlanta. A common scenario he has seen is when a father discusses the loan terms with his child yet fails to include the mother in the conversation. Then when the father dies, the adult child insists to the mother that the father forgave the loan before he died.

“Now Mom has to decide if her child is telling the truth,” Miller warns. He suggests using caution with such arrangements. “I generally advise clients that they probably shouldn’t loan any amount of money they can’t stand to lose."