Bryan Tracy, CFA, CFP®
Vice President & Director of Financial Planning

Whether you are in the market to buy a house or not, you are likely aware that housing prices remain sky-high. With low housing inventories and demand outweighing the limited supply, we are currently experiencing the highest annual rate of price growth in the last 35 years.[1] Median existing-home price rose 14.8% in April from just a year earlier, to a record high of $391,200[2].

As mortgage rates have also recently climbed, the change in interest rates has made homeownership more expensive, forcing some buyers to reconsider a home purchase. This was clear as sales of newly built homes in April fell 16.6%, their most significant monthly drop since 2013, according to the U.S. Department of Commerce. New-home sales are a leading indicator of the housing market, which causes many to think the market is peaking. The drop in April could be a positive sign that record home prices and rising mortgage rates are finally cooling the housing market.

The Federal Reserve’s pullback from the mortgage-bond market is driving up rates on home loans, which is likely to continue as the Fed takes effort to fight rising inflation. Prospective homebuyers originally quoted rates well below 4% at the start of their home search may now face rates near 6%.

To help combat the effects of rising mortgage rates, undeterred home buyers have some money-saving strategies to consider. Some may opt to pay higher down payments to lower the amount they finance, or by paying additional fees to secure lower rates through rate-lock agreements and discount points. The amount of discount points and loan-origination costs used in April increased 31% from a year earlier[3]. Buyers are also looking at Adjustable-Rate Mortgages (ARMs) with lower introductory rates that reset in five, seven, or ten years. Regulations enacted as a result of the 2008 – 2009 financial crisis have enhanced protection for borrowers in an effort to mitigate future potential crises, however, to qualify, applicants must be able to afford mortgage payments at rates significantly higher than the starting rate.

The considerations in this article are general guidelines highlighting some of the most pertinent details to help navigate the current home buying process.

How much house can you afford?

It is critical to know how much house you can afford before locking into an agreement. Primary factors include your household income, monthly debts, and savings.

A general recommendation is to start with 3-5 times your household income to target a purchase price. If you don’t have debt you can err towards the higher side of that range. It is prudent to also save an amount equal to at least your annual household income before purchasing a home, to cover the down payment, closing costs, and unexpected other expenses.

Bank preapproval is next. An important metric that banks use to determine the size of the loan you qualify for is called your debt-to-income ratio. This is your monthly debt obligations divided by your monthly pre-tax income. Banks further factor in credit score and other elements, but they generally limit loans to 36%-43% of your monthly income. A more conservative ratio will allow a cushion for savings, maintenance, and unplanned housing emergencies.

Helping a loved one with their home purchase

This higher price environment may create an opportunity for you to help a loved one with their home purchase. There are a number of different solutions based on your unique situation and what outcomes you ultimately want to achieve. Below are a few initial questions you should ask yourself before proceeding:

  • Do you want to make a gift or do you expect repayment?
  • What type of control or responsibility do you want to have after the home is purchased, if any?
  • Would having a trustee involved in the purchase and ownership of the home be beneficial?
  • Is the buyer also contributing to the purchase?

Below are a few different approaches to helping someone else in their home purchase.

  1. Gift the funds outright

Directly gifting the funds tends to be the simplest way to help as it doesn’t require outside counsel or formal agreements. It’s important to note, this option leaves the gifter with no control of how the funds are actually used. If your gift exceeds the annual gift tax exclusion of $16,000, you must file a gift tax return or form 709 to report the gift. No gift tax is due unless you have already used your full lifetime gift tax exemption, which is currently $12,060,000[4].

  1. Lend the funds with the expectation of repayment

Loaning the funds is a strategy to consider if you expect to receive the funds back for your own retirement or for another purpose. Of course, entering such agreements with family members needs to be very carefully thought out, including the impact on family dynamics and the likelihood of repayment. To avoid any potential gift tax consequences, the recipient must pay you at least the IRS minimum interest rate known as the applicable federal rate.

  1. Gift or loan in trust

A more complex strategy is to make an outright gift or loan through an Irrevocable Trust. This gives you the control to structure the arrangement to give as much or as little responsibility to the home buyer as you feel comfortable with. For example, if you want to provide your child with a home, but don’t think that they are able to manage the assets, you can select a trustee, such as the Haverford Trust Company, to have the responsibility of making payments or making decisions about selling the home in the future, and what to do with any sale proceeds. Benefits of this strategy include potential protection from creditors or in the event of divorce, as well as potential income tax or estate planning benefits.

  1. Having ownership through a joint purchase

A joint purchase allows you to retain ownership of the house in accordance with your contribution to the purchase price. Having a well-defined plan is imperative before going into any such agreement as co-ownership can create opportunities for potential conflicts. Decisions around who is paying for certain expenses or maintenance and when to sell the house should be discussed in advance of any purchase. Similarly, you may decide to purchase the home and retain full ownership. Estate plans will need to reflect the owned or co-owned home, and what happens to your interest after your passing.

No matter what strategy you think is right for you, your family, and your unique circumstance, we advise that you consult with your team of trusted advisors to make sure all parties are protected.

[1] As per the S&P CoreLogic Case-Shiller National Home Price Index started recording prices in 1987.

[2] In data going back to 1999

[3] According to estimates from the National Association of Realtors.

[4] Exclusion amounts as of 2022 tax laws.