Bank of Mom & Dad: What Goes Around, Comes Around!
March 21, 2016 | Posted by: Kelleway Mortgage Architects
We, as mortgage brokers, often see parents helping their home-buying children by offering monetary gifts towards down payments. A question in the back of my mind is: What’s the impact on the parents’ finances now with more adult children looking for additional funds to cover their need for larger down payments? (See new Canadian mortgage regulation in effect February 15, 2016). Will the “Bank of Mom & Dad” be tapped for more funds? We know the answer is “Yes”, especially in higher-priced metropolitan areas such as Vancouver, BC.
Parents seem to be giving larger amounts to help their children buy their first home, what effect will that have on the parents’ savings and future retirement income?
- Home Buying Adult Children Are Expected to Service the Debt
- Gifted Downpayments – Low to High Range Amounts
- Gifted Downpayments vs Non-Arms Length Loans
- Extended Family Housing
- What?! No Subject to Financing Clause???
Home Buying Adult Children Are Expected to Service the Debt. Managing expectations from the start is crucial for preventing future disappointment. Even with down payment help from parents, adult children buying homes are normally expected to debt service their own mortgage, pay their closing costs on the purchase, and cover other property costs such as property taxes, strata fees, utilities and home maintenance. In short, home buyers are expected to earn enough income to at least cover their monthly living expenses. Occasionally, I do see parents temporarily contributing to those monthly payments too. For example, at times the adult children are not earning their full income while completing post-secondary education, are on parental leave, or perhaps facing an economic downturn.
Special lending programs may make it possible for me to arrange more mortgage than adult children can manage on their own to purchase a higher priced home. However, I often caution parents if I think the buyers are stretching their income too thinly in order to routinely carry the newly acquired mortgage and other expenses. Tradeoffs may have to be made in order for home buyers to find the right combination of price, space and location that will comfortably fit their financial capacity. (Contact Me)
For many families with children, or expecting children, buying “the” single detached family home with yard may not be financially feasible. Other alternatives could be:
1) something smaller such as a three bedroom condo or townhome, and/or
2) moving out further from the urban core to a location with access to public transportation, and/or
3) purchasing a property that generates rental income from a suite.
When a person is buying only for himself or herself, or perhaps one other adult, we are seeing them opt for homes that fit their current lifestyle. How and where they spend their workdays and days off in terms of social activities and recreation seem to be higher priorities in their home buying decision. Fewer of these one and two-person households are interested in spending their time on household upkeep and yard maintenance.
There is a lot to know about purchasing a home that is right for you and getting the help of a knowledgeable and experienced realtor is important. He or she can make a significant difference by preparing buyers and professionally protecting them from making costly mistakes when purchasing a home. Call us and we will recommend a realtor in your area who can work with you to find the right home for you. (Contact Me)
Gifted Downpayments – Low to High Range Amounts. For clients we serve, we’ve seen gifted down payments range from $2,000 up to $800,000. For young first time buyers, that gift towards down payment, combined with some savings, may be just what’s needed for adult children to enter the home owning market. Or, that gifted amount could shift a 5% down payment required for a default insured mortgage (i.e., via CMHC or Genworth) to a 20% down payment required for a conventional mortgage. With conventional mortgage financing, first time buyers (or next time buyers) can avoid adding the default insurance premium required by law to their total mortgage amount. Another benefit of qualifying for conventional financing is that the lender may allow buyers in some cases to extend their amortization up to 35 years. That extension may result in more manageable mortgage payments or the opportunity of purchasing a property at a slightly higher price point.
If parents have ample cash on hand, they are likely to hand over a cheque or bank draft to provide the down payment gift. If parents are willing to cash in some RRSPs for that purpose, they need to be aware of income tax consequences. A different approach is for parents to loan money to their children from their RRSPs. Ask me (Glen Kelleway) to explain how this can be done. (Contact Me)
Gifted Downpayments vs Non-Arms Length Loans. Regardless of whether the down payment is gifted or loaned, I want to clear up a common misconception as to how the amount can affect the buyers’ purchasing power. Let’s say the buyers have $50,000 for a down payment on a $300,000 home; thereby, they need a mortgage in the amount of $250,000. If the “Bank of Mom & Dad” allows them to increase the down payment amount to $200,000, their purchasing power only increases to $450,000 (i.e., $200,000 down payment + $250,000 mortgage). Just because the down payment went up by a factor of four (i.e., $50k to $200k) DOES NOT mean the buying power went up by a factor of four (i.e., $300k x 4 = $1,200k). Having said that, there are some special rules that can apply to some borrowers if the down payment amounts to 35% or more.
Please note: Borrowers having lots of home equity is comforting to lenders. However, the lender does not have to automatically approve a mortgage for the borrowers (e.g., adult children) even if the down payment is large. Ideally, the adult children need to qualify on their own for the mortgage part of the purchase price. The initial down payment (i.e., home equity) cannot be considered a source of future mortgage payments. In the absence of income, lenders need to verify with documents that the borrowers have adequate savings and investments from which the mortgage will be paid.
To offer their home buying children a large down payment amount, the parents may be borrowing from their own home equity or RRSPs. Rather than a gift, the down payment could be registered against the property as a second mortgage. This could be a non-arms length loan on which the parents charge their children some or no interest until the loan is repaid sometime in the future. Ask me how this is done.
When large amounts are involved, some parents prefer “loaning” rather than “gifting” the amount. This is a way of protecting their monetary contribution in the event that their adult child’s current or future spousal relationship dissolves and assets are divided, including home equity. If a non-arms length loan is preferable to a gift, both buyers and their parents can discuss that option with me to make the necessary arrangements - including proper disclosure to mortgage lenders. Call me to discuss this. (Contact Me)
To find out how their gift or loan could affect their income taxes and planning for retirement, we advise parents to consult with their own financial advisors.
Extended Family Housing. Here’s a test for deciding whether purchasing shared housing with extended family is right for you. One of our clients describes two distances in living proximity to family. One distance allows you to frequently “walk to their home in your pajamas” and the other requires “taking a trip and packing your pajamas in a suit case”.
If the pajama closeness doesn’t bother you, then combining extended family into one big shared house can have its benefits. For example, if the parents are near or in retirement, they may be “house rich” with home equity and “cash poor” with income. The adult children may be just the opposite with little home equity and high monthly income. By combining two households into one, financing issues can balance out. There may also be some additional benefits with regard to managing elder care, child care, transportation costs, household maintenance and other shared living costs. (Contact Me)
What?! No Subject to Financing Clause??? This sometimes happens when buyers and sellers are negotiating a purchase and sale agreement in a hot real estate market.
Everyone benefits (buyers, sellers and their realtors) when the buyers’ income, down payment and credit history have been reviewed in advance of the offer to purchase. To avoid problems with last minute arrival of gifted down payment, we recommend that the full amount be in the buyer(s) bank account BEFORE an offer to purchase is made.
We will issue a Preliminary Approval letter to the buyer(s) once we are satisfied that income, down payment and credit history will meet several lenders’ criteria to get a client approved for financing. In multiple offer real estate deals, our Preliminary Approval letter has been a strong negotiating tool for getting our clients’ offer accepted for buying the home they want.
Legalities. Rule of thumb? When multiple parties and significant amounts of money and real estate are involved, the relationship amongst parties gets more complicated. A good idea to maintain friendly relationships is for all family members involved with the purchase to meet with a legal advisor. The legal advisor can help document ownership rights and future monies owed amongst parents and adult children. (Contact Me)
When borrowers are buying with extended family, we need to speak with all parties involved in the purchase. Here’s some questions to consider.
1) Who amongst the parties to a purchase should be placed on title of the property?
2) Who will the lenders accept to be on title of the property and on the mortgage contract?
3) What proportion of property ownership is held by each party as joint tenants or tenants in common?
4) What are the responsibilities and liabilities of co-borrowers, co-owners and guarantors with regard to the purchase of the property, repayment of the mortgage and future sale of the property?
5) What if one of the parties later wants to be removed from the title of the property and the mortgage contract prior to a sale, mortgage renewal or refinance? What is the process for handling that request and any distribution of home equity?
6) What happens to the property if one of the principle buyers no longer lives on the mortgaged property as a result of separation, divorce, permanent disability or death?
7) How will net proceeds (or loss) be distributed amongst the parties if the property is later refinanced, sold or foreclosed upon?
If you have any questions about the above information, please do not hesitate to call me (Glen Kelleway) for help or explanation.
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Glen Kelleway, BSc, AMP, Senior Mortgage Planner & Owner
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