With prices continuing to rise and stricter rules governing mortgage qualifications, a growing number of first-time homebuyers are turning to the “bank of mom and dad” to get into the housing market.
A survey conducted in December 2018 by financial website Finder.com found that 67% of Canadian parents help their children financially – with 20% providing financial assistance with a major purchase such as a house. That parental support can be extremely helpful when you consider that the average price of a new home in Canada is now $495,000, according to the Canadian Real Estate Association (CREA). In markets such as Toronto and Vancouver, the average house price is $1 million.
On top of steep prices, the federal government passed new rules in 2018 that make it harder than ever for people to qualify for a mortgage from a traditional bank. The new rules require a more stringent stress test to prove that a mortgage applicant can withstand higher interest rates.
Financial institutions now review mortgage applications by using a minimum qualifying rate equal to the greater of the Bank of Canada’s five-year benchmark rate (currently 5.34%) or the lender’s contractual rate plus two additional percentage points. A full 10% of Canadians who got a mortgage in 2016 and 2017 would not qualify under the new regulations, according to an analysis by the Bank of Canada.
In this climate, first-time homebuyers need all the help they can get. And it’s natural for parents to want to help their children secure a house to both live in and have for a long-term investment.
“It is quite common today for parents to help their children enter the housing market. It’s something we’re seeing more often,” says Brent Soucie, Vice President & Financial Consultant at T.E. Wealth in Toronto. “There are a number of things every parent should be aware of when providing assistance with a major purchase.”
Assess your own finances
The first question that every parent should ask when considering whether to assist a child with a house purchase is: “Can I afford to help?” The answer will require you to scrutinize your own finances – especially if you’re close to retiring or are living in retirement already. Wesley Fong, a financial consultant in T.E. Wealth’s Vancouver office, says “You need to carefully consider the impact that this may have on your financial situation and your ability to live comfortably throughout retirement.”
As a general rule, it is best to use available cash to help your children with a down payment on a house. It is never advisable to dip into savings, especially a Registered Retirement Savings Plan (RRSP), to give money to a loved one. Not only will you diminish your long-term financial security, but you will also be hit with steep taxes if you take money out of a registered account. The withholding tax on an RRSP withdrawal can be as high as 30%, and the amount you take out will be added to your tax return as income for the year.
You could use a Home Equity Line of Credit (HELOC) or unsecured line of credit to get money to help your children. You could also take out a second mortgage on your own house. But, in these instances, you would be going into debt and subject to interest charges. Be sure that you are able to pay off any debt in a timely manner.
“If parents have the funds to help, it can be a tremendous boost to the first-time home buyer,” says Darin Yuzyk, Vice President, Financial Education & Employer Services at T.E. Wealth in Calgary. “But do the math and be sure that you’re able to help without putting your own plan in jeopardy.”
Gift versus loan
Once you’ve determined that you have the means to help a child purchase a house, the next step is to decide how you want to provide that financial assistance. This will require you to choose whether to give the money as a gift with no expectation of it being repaid, or extend a loan that must be paid back over time. There are pros and cons to each approach.
In addition to being a nice gesture, gifting money to a child comes with tax advantages. This is because, unlike other countries such as the United States, there is no “gift tax” in Canada. Giving money to your children while you’re alive also means that there will be less estate tax (i.e., probate) charged to your heirs if money transfers to them when you die. Gifting money to your children essentially keeps it out of the hands of the Canada Revenue Agency (CRA).
“Gifting money to a child is the easiest and most straightforward approach,” says Anne Rivard, a financial consultant at T.E. Wealth in Quebec City. “It can also remove some of the emotional entanglements that can arise when family and money are involved.”
On the flipside, by giving money away while you’re still alive, you could hurt yourself financially if you suffer an unexpected setback. Also, keep in mind future long-term care needs. The average long-term care facility in Canada costs between $1,000 and $5,000 per month, according to TheCareGuide.com.
In lieu of a gift, you might consider extending a loan to help a child enter the housing market. This could be a low interest or zero interest loan that is to be repaid over a period of time agreed upon by you and your child. Taking this approach gives the child the money they need to buy a house, and lets them avoid hefty interest charges, while also ensuring that you get your money back.
“If you do decide to lend your children the funds they need in order to purchase a home, it’s advisable to have a written loan agreement signed and in place,” says Mr. Soucie in Toronto. “Also, consider who your child marries. If their marriage were to break down, the equity in their matrimonial home would typically be split 50/50.”
Co-signing a mortgage
If you don’t have cash on hand to give your child, either as a gift or a loan, another option is to co-sign a mortgage with your child. Financial institutions will often provide a larger mortgage amount if there is a co-signer on the title document. However, this approach carries substantial risks. If, for whatever reason, your child defaults on the mortgage payments, you will be on the hook for them.
“Co-signing is an option, but it places a lot of responsibility on everyone involved,” says Ms. Rivard in Quebec City. “Children have a responsibility to meet their mortgage obligations, and, if they fail to do so, the parents will be on the hook.”
Helping your children buy a house requires careful consideration and planning. Whether you can afford to help depends on your financial situation and retirement plans. And whether you provide assistance with a monetary gift, a loan, or by co-signing a mortgage will depend on factors ranging from how much cash you have available to the maturity of your child and the relationship you have with a child`s spouse. If you’re unsure which approach to take, get professional advice from a financial consultant.
Joel Baglole is an independent financial writer.
This article was published in T.E. Wealth’s Strategies newsletter, March 2019 edition. Read the full edition here.