It’s an exciting time for the Wolff family. Laura, an only child, begins her second year of college this fall — and, for the first time, she’ll be living truly on her own.
As a freshman, Laura was required to stay in on-campus housing, at a cost of nearly $11,000 for basic room and board. This year, since she has the option, she’d rather live off-campus with two long-time friends in a shared house or an apartment.
Her parents are researching the cost and availability of rentals near campus. But they’ve also heard of families who found another alternative.
Increasingly, parents are leveraging low interest rates to buy their children college condos or single-family homes as an alternative to dorms or rental apartments. Often, they’ve made the rent-or-buy decision based simply on a comparison of cash flows. But a cash flow analysis overlooks other critical considerations in buying a college condo.
The statistics are eye-opening. Roughly one in four college students will either change schools or drop out after the first year. And half of all students who enroll in a four-year college never actually earn a degree from that college, according to the National Center for Education Statistics.
If there’s a reasonable chance that your son or daughter will want to change schools before earning a degree — or spend a semester or two abroad — would you buy your college student an off-campus home, at least during the first year or two? Or would you prefer to limit the risk by renting?
It’s just one of the many personal, financial and tax considerations that factor into the analysis when deciding to rent or buy off-campus real estate, including college condos.
Before you seriously consider the financial implications of buying a property for your child’s college years, there are important nonfinancial concerns to address. They include your child’s maturity and readiness to both maintain a home and possibly function as a landlord for one or more rent-paying roommates.
They also include your own motivation. Why are you buying the property? Do you intend to sell it as soon as your child graduates, hold onto it until a younger child attends college, or simply maintain it as an investment? What do you hope to gain from the purchase?
Cash flow is an obvious factor in the decision-making process for most parents: Will it be more or less expensive to buy as opposed to renting — and by how much?
You’ll likely incur up-front costs to acquire the college condo property, such as the appraisal fee, down payment and various closing costs. Major monthly expenses to maintain the property generally include the following:
principal and interest payments on the mortgage, if any
repairs and replacements
homeowner’s dues for a condo or townhouse
insurance on the structure and contents
living expenses such as the cost of cable, heating and cooling, electricity, garbage collection and other utilities
If your child will have roommates, how much do you plan to charge them and can they be depended upon to pay their share of the rent on time each month? What will you do if a roommate-renter moves out and how long are you willing to carry the mortgage without replacing the roommate? And will your child and roommates occupy the property all twelve months of the year or only during the school year?
What are your potential liabilities if a roommate is hurt on the property or loses personal possessions in a robbery or fire? Are you adequately insured? To enhance your liability protection, you might consider creating a limited liability company (LLC) to own the property.
Aside from the recurring cash flow issues, are you counting on the property to maintain or increase in value during your ownership? Property values can fluctuate significantly in some markets and you may not be able to count on real estate appreciating over relatively short periods of time. If you plan to sell in a few years, the commissions and closing costs will reduce any potential profit. Are you financially prepared for a loss in value — even one that might negate any other financial benefits of ownership?
If you’re planning to sell the college condo property when your child graduates, you might be able to reduce your monthly cash expenditures by considering an adjustable rate mortgage (ARM) or an interest-only mortgage as an alternative to a fixed-rate mortgage. In either of these cases, you may be considered to own the condo or home as an investment property, generally with a higher interest rate and closing costs and a different set of tax rules.
There is an alternative, however, that offers a lower owner-occupied interest rate (and associated tax benefits) combined with a low down payment. It’s the FHA non-occupying co-borrower loan — also known as a kiddie condo mortgage — which can be used to purchase a townhouse or single-family home as well as a condo. The mortgage option allows you (or another blood relative) to help your child buy a first home and establish a credit rating. Although the home is considered your child’s primary residence, both you and your child must qualify and sign for the loan and you’ll both take title to the property.
The rules and requirements are fairly complex, so it’s important to speak with an experienced FHA lender with a background in non-occupying co-borrower mortgages. You’ll find additional information on these mortgages online at the FHA Info.com website. You can also refer to the FHA’s news blog, including the following blog posts: FHA Loans: Can a Parent and Child Apply for an FHA Mortgage Together? and FHA Loans: Non-Occupying Co-borrower Requirements.
If you want to own the new property yourself, but as a second home and not an investment property, there are a number of specific requirements. Generally, to qualify as a second home, the new property cannot be close to your primary residence and you must occupy it for at least part of the year. Some lenders even require that the second home be in a resort location.
One mortgage product that allows you to purchase the property as a second home without such requirements — often referred to as a Family Opportunity Mortgage — is offered through a special Fannie Mae/Freddie Mac program. The loan program has its own set of requirements governing availability and qualifications, so consult with an experienced mortgage lender.
Here’s where you really need the advice of an expert.
There are federal and state tax implications that vary depending on how you own, finance and fund monthly expenditures for the college condo property. For example, maintaining a primary residence in another state may subject your child to state income taxes. Rental income from roommates is subject to federal and possible state taxes. A number of federal tax deductions and other benefits are determined based on your ownership of the property, as an investment or personal residence. Do you want deductions to flow through your tax return or your child’s return? Importantly, there are significant limitations governing who can claim these deductions and how they are reported. They may not generate a current tax benefit.
When you sell, the manner of your ownership may also affect the tax consequences of the sale.
If you’re considering purchasing a condo or other property for your child to live in while at college, give us a call before you make a commitment. We can help you model possible scenarios from a cash flow and an overall investment perspective, including the impact of taxes on the financial analysis.
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