Is Your Loan Trapped in Your Kid’s Divorce?
If you read any kind of news feed today, the topic du jour is housing affordability. And the reason it is the topic is because prices have been insane for four years. This is especially true in the “starter” part of the markets which was once $250,000 to $300,000. Today these homes in Southeastern Pennsylvania are $400-500,000 homes and the people who buy them did not see a one-third increase in their income during the corresponding period.
What this means is that lots of parents of children who are thirtysomething want their kids to have a home. The kids want homes. But it takes a lot of cash to get into a three bedroom crib today. And that cash often involves Generation X or Boomer money is called into the transaction.
If you have been on the receiving end of that call you know how it works. It’s your son or daughter calling on behalf of their spouse asking if you can help. The earnest or “down” money would have been $35,000 a few years ago but now its twice that amount and the young couple is coming up short. Worse yet is that at the height of the market sellers wanted cash offers and the idea was you front cash so the kids could buy the house, then they would find a suitable mortgage for 3.5%.
Most parents in these transactions suggest they will “lend” to make the deal possible but they are not able to “give” without raiding their own nest egg of significant capital. So the elders come through and agree to “lend” the shortfall of the deposit money.
Simple enough…until it isn’t. As the mortgage underwriters grind through the paperwork they ask to see the sources of the deposit. The problem here is that mortgage companies don’t want to hear about any other lenders. They will nix a deal if the parents are owed money. Rather they want their file to include a letter saying the parents’ $35,000 contribution is a gift. Hmmmmm. This produces a wink-wink, nod-nod meeting where the parents sign the letter and the kids say “We understand…we’ll pay you back.” Meanwhile, the mortgage file has the infamous gift letter saying quite the opposite.
This is a divorce blog so you can tell what happens next. A few years later the happy couple who borrowed part of the down money with a wink, a nod and that nettlesome gift letter aren’t so happy anymore. In fact, they have lawyered up. If there ever were payments since settlement to reduce the $35,000 gift, they have now stopped, leaving you wondering what really is the status of the $35,000 you put in.
Let’s assume the purchase which you helped finance involved your daughter and son-in-law. What’s your move? Often the assumption is that you should join forces with your loving daughter; perhaps hire her lawyer to make certain your $35,000 comes home. Unfortunately, this doesn’t work. If you are a creditor, you are adverse to your daughter, who is a debtor. And realize that your no-good son-in-law is going to throw that gift letter in your face in a legal sense. If the once happy couple has made payments since settlement to retire your claimed $35,000 debt you have a colorable claim but be ready for the argument that this was not a real debt but that your daughter and son-in-law showed their gratitude for your gift by gifting money back to you.
The next question is “where” you go with your claim to get money back. In an ideal world your daughter and son-in-law signed a note to repay the $35,000. You could sue on the note but expect a defense that the note lacked consideration because you’re suing to collect the same money you gave the couple per the letter you signed. Even without a note you can sue for a debt. It’s just not certain you will win that suit.
Returning to the “where” question your claim has two possible homes. You can sue your daughter and son-in-law in an independent action that makes no reference to the pending divorce. Rule 1920.34 of the Pennsylvania Rules of Civil Procedure provides additional support. This rule states in pertinent part: “At any state of an action, the court may order the joinder of any additional person who could have joined or been joined in the action and may stay the proceedings in whole or in part until such person has been joined.”
You need some independent advice on this topic; whether you want your claims consolidated with your kid’s divorce or whether you want to steer clear of that mess and keep life simple, i.e., “I loaned the money and I want it back.” The procedures employed in divorce are quite different and your claims are part of a litany of claims between the divorcing parties. Some of that could play in your favor; some may play against you. In a separate action, your claims are not immersed in the 13 factor analysis related to distribution of assets and liabilities created during the marriage. Realize as well in a divorce that the court may try to allocate the debt due you between the formerly happy couple. The procedure to decide your “civil contract” claims in a “civil divorce” action is murky. A civil claim has a procedure for post-trial motions. Pa.R.C.P. 227.1. Divorce law uses a different procedure. Pa,R.C.P. 1930.2.
As parents you want to help an adult child secure a piece of the American dream. But your help in providing earnest money to make the transaction go through puts that money at risk of treatment as a gift which is non-recoverable. There may be other ways to structure the transaction, but those options may be pregnant with other risks; e.g., loss of the mortgage interest deduction on personal tax returns. The key here is to get independent advice before the transaction because your interests do not coincide with those of your child and his/her spouse. You may choose to proceed despite risks. But you need to understand what could happen if things go.
