Helping Your Kids Buy a Home
Home ownership is something Canadians cherish. But for many young adults the dream has remained just that, especially in Metro Vancouver’s ultra-pricey housing market.
Though they've been fortunate to miss out on the high mortgage rates their boomer parents had to endure, expensive real estate, tightened mortgage rules, overhanging student debt and stagnant incomes haven't made it easy for the next generation of home buyers to get into a place of their own.
If you're the parent or grandparent of an aspiring homeowner it's natural to want to help – but how?
If not planned properly your good intentions can wind up hurting your relationship with your child or other family members, and even put your own finances in jeopardy.
What to assess before stepping up
It's nice to be generous in helping a child buy a home, but that generosity needs to fit the situation, yours and theirs.
First look at your own circumstances. It's important that whatever help you extend you don't risk your own financial security. If you're thinking of selling investments or going as far as downsizing your home to free up capital, make sure you can live without those funds you're about to give away. Review your plans with your advisor to be confident your act of kindness won't negatively impact your finances today or your retirement tomorrow.
Next, assess your child's desire and readiness to become a homeowner. Simply giving them whatever help they want, whenever they want it, risks creating a sense of entitlement which can hold back their financial independence. It can also strain relations if you eventually have to say "no".
If your child can't qualify for a mortgage on their own, understand the reasons why. Is it simply that they don't earn enough or are there skeletons in their financial closet that should make you think twice about how you partner with them?
Ask why it's important they buy now. Delaying a purchase has its benefits. Your child can accumulate a larger down payment, which could translate into lower borrowing costs over the life of a mortgage. And, being a little older and wiser should help them better handle the responsibilities of owning a home.
Discuss the good and bad experiences you've had in order to set realistic expectations of what home ownership is all about. Remind your child that as a young person with a mortgage they could have a lot less flexibility in other areas of their lives. It might not be easy to travel, go back to school, or have the full social life they've come to enjoy. What if they want to relocate for career reasons? Things can be more difficult once you're a home owner.
Strategies to help with home ownership
If you conclude your pocketbook can handle the expense of helping out and your child's ready to take on home ownership you have several options.
1. Make a cash gift
The most straightforward method of helping a child buy a home is to simply give them the money to cover some or all of the purchase, or chip in for the property's carrying costs. If you give enough so that your child can put up at least 20% of the purchase price they may avoid CMHC mortgage insurance fees.
There are some tax considerations to keep in mind if you choose this approach.
The good news is because the gift is being made to an adult child income attribution rules don't apply, so there are no tax consequences to the cash transfer itself. A gift now, instead of later through your will, has the added benefit of avoiding probate fees. However, if you have to liquidate investments to raise the money you might incur taxable capital gains (or losses) in the process.
Don't forget to put the title to the home in your child's name, not yours. That way it serves as a principal residence for them, instead of a secondary property for you, which could possibly trigger capital gains tax when it's eventually sold.
2. Loan the money
Some argue that avoiding a handout and offering a loan instead is a better way to give a child a hand up in buying a home.
A unique benefit of a loan is educational as a child faces the discipline of making regular mortgage payments to you. You can set the loan's interest rate so you both benefit: lower than what a traditional lender would demand, but higher than what your funds might otherwise earn in a savings account. Unless you choose to lend the money free of charge, any loan interest must be declared as income in your hands.
Some parents like the commitment having a loan requires, but still want to maximize the assistance they offer their children. One approach that can let you do both is to quietly set aside your child's loan payments in separate account. Those funds can then build into a nest egg you can give at a later date for a special purpose like buying furniture, taking a trip or investing in a TFSA.
3. Co-sign the loan
Having enough income to qualify for a mortgage is a significant challenge for many young adults. For years rising home prices have far outpaced wage growth. Agreeing to co-sign for your child's mortgage can strengthen their application and help them get approved. But while the benefit of co-signing may be obvious, the risks sometimes aren't.
Once you co-sign you are on title to the property and share legal responsibility if anything goes wrong. Because you're an owner you're fully liable for the mortgage debt if your child defaults, possibly putting your own credit rating at risk. Also, weigh the fact that co-signing can crimp your own ability to borrow in the future.
Keep in mind that co-signing may limit a child's mortgage choices. If they apply on their own your child could be eligible for a high-ratio mortgage with as little as 5% down. However if you co-sign and already have a mortgage your child is restricted to qualifying for a conventional mortgage, requiring a minimum 20% down payment.
4. Buy a property and rent it to them
Buying a home and then renting it out to your child, perhaps with an eye to selling or gifting it to them later, is an alternative to owning immediately. While this strategy takes the responsibility of managing a home away from them, it changes the picture significantly for you.
You essentially become an investor, with the upside potential but also the headaches and downside risk of owning rental property. Be aware that this living arrangement won't help your child build their credit rating.
As a landlord you'll have to claim your child's rental payments as income, but can deduct any borrowing charges and qualifying expenses of maintaining the home. Plus there may be tax implications when you do eventually sell or gift the property.
And lastly, a growing trend is co-ownership. For example, you can turn your house into a duplex so your child can live in one portion while you live in the other. Or you can buy a new place that accommodates both parties. If this is the option you choose, there are lots of questions that would need to be sorted out in advance, and an agreement is critical.
Remember to clarify your intentions
While helping a child buy a home may be noble, it can spark confusion and resentment within a family. That's why it's essential to clarify your intentions through your estate plan.
For example, if you give cash, is that gift an advance on that child's inheritance? If you offer a loan, do you intend that the loan be forgiven on your passing, or should the amount owed be deducted against what the child will receive from your estate? Communicating your plans to your loved ones and committing to those plans in your will can save misunderstandings and hard feelings later.
There is no one right answer on how to help a child buy a home. What's clear is it's a decision that shouldn't be taken lightly, on your part or theirs.
While we've outlined a few of the ways you can assist, any strategy comes with a myriad of financial and legal considerations.
No matter your choice, the keys are to avoid putting your own financial security at risk and add the proper safeguards to protect all the parties involved. Above all, get professional guidance.