Helping Your Kids Get into a Home of Their Own
You can be the key to unlocking the door to their home ownership.
If you’re a parent who’s considering lending your child a hand to purchase a home, you’re not alone. It’s reported that across Canada, gifts from the Bank of Mom and Dad to adult children for a down payment doubled between 2000 and 2016.1 In a BlueShore Financial online panel survey of clients, 60% of parents (aged 55+) have or are planning to provide assistance for their children’s first-time home purchase.
Your help could make all the difference in how quickly your kids get a foothold in our competitive real estate market. But unless you make the right choices, those good intentions can turn into family conflict, tax headaches and legal battles – you might even harm your own finances.
The affordability crunch marches on
Our real estate market has bounced back sharply from the correction in the second half of last year. Greater Vancouver benchmark home prices have now eclipsed 2016’s historic highs seen prior to the introduction of the foreign buyer tax, across all residential types.
While single-family houses in Metro Vancouver have been out of reach for local first-time buyers for some time, sticker shock is now creeping into condominiums and townhouses too.
According to the Real Estate Board of Greater Vancouver, the benchmark price for a condominium rose 15% in the first half of the year, more than twice the increase in the detached market. Want to purchase a typical condo in North Vancouver? Be prepared to pay about 17% more than a year ago.
National Bank’s Housing Affordability Monitor notes the first quarter was the seventh straight period of worsening affordability nationally – the longest stretch in nearly three decades – led by Toronto and Vancouver.
Market dynamics aren’t the only factors pressuring affordability. With tougher mortgage standards and regulations impacting the amount some individuals can borrow, heavier student debt loads carried by Millennials, and sluggish growth in real median incomes, it’s no surprise family help for first-time homebuyers is quickly becoming the norm.
Ways to lend a hand
If you want to help your children unlock the door to home ownership, you have various ways to go about it. Here are four strategies to consider.
1. Give cash
Perhaps the easiest way to assist your child is to offer a cash gift. If you give enough so their down payment is at least 20% of the purchase price, they can avoid a high-ratio mortgage and the extra cost of mortgage insurance.
There are no tax consequences to making the cash gift itself. However, if you must liquidate investments or other assets to come up with the funds, you could trigger capital gains or losses when you sell. Also, expect potential lenders to ask you to provide a letter confirming the money is a gift that doesn’t require repayment and therefore won’t add to your child’s debt.
While handing over cash is simple, it doesn’t come without risks. Once you give away the money it’s gone. That’s a problem if you later need the funds for yourself. And, should marital strife strike, your child’s spouse or partner could make claims on the property your gift was used to purchase. Your child’s creditors could do the same. Seek legal advice before you act so you’re properly protected.
If you own a second home, you have an alternative. Instead of gifting cash, consider granting your child the property itself. The transfer happens at fair market value, meaning you may face capital gains taxes if the property has increased in price and you’re not able to claim it as a principal residence. But, assuming the home becomes your child’s primary residence, they can look to shelter any future gains using their principal residence exemption.
2. Lend them the money
Parents can be reluctant to give a gift for fear of fostering a sense of entitlement or dependence in their kids. If that’s you, consider lending them the money instead.
A beauty of a loan is its flexibility. If income isn’t what you need, set a zero-interest rate so your child only has to pay back the loan principal. Or, leave them with the responsibility of paying interest as they would to a traditional lender, but offer a preferred rate. Later, you could choose to turn your loan into a gift and forgive the outstanding debt entirely.
Be aware that any interest payments you receive are taxable in your hands. Plus, when you lend the money you’re essentially becoming your child’s banker. That includes accepting the possibility they may miss payments or fail to pay back the loan in full.
3. Co-sign their mortgage
Having good credit is important for anyone looking to finance a home purchase. Even if you donate the entire down payment, a lender will still want to be confident your child can meet their commitments.
The difficulty for young people is they may not have had enough time to build a solid credit profile that lets them borrow effectively. In this situation, parents often step in as guarantors, using their financial clout to strengthen their child’s mortgage application. Taking this route can mean securing a more favourable interest rate and greater borrowing capacity.
When you co-sign, you don’t have to worry about selling assets or parting with your savings to help. However, you become a legal partner in the home purchase and share the risks. Say your child defaults on their mortgage obligations; you’ll be on the hook for what’s owing. That can pressure your credit rating. What’s more, co-signing puts an extra debt burden on you, potentially restricting your capability to borrow for your own needs.
4. Buy a home to rent to your child
For a young adult who’s not yet ready to assume the responsibilities of home ownership, there’s another option: buy a home and rent it to them. And, you could leverage the home equity you’ve built up over the years to do it.
As an investment property, if you finance its purchase the interest payments become tax deductible. The same goes for eligible expenses to maintain the home. Any increase in its value is subject to capital gains tax if you later sell or pass title on to your child. Of course, you’ll have to get used to the idea of being a landlord. But at least you’ll keep their rent money in the family.
Remember, if you choose to borrow against your home’s value, you’ll also be tying up equity you could put to a different use.
As an alternative to purchasing a separate property, constructing a laneway house is becoming a popular choice for creating a living space for adult children, right next door to their parents and in prime locations. With this approach, you have the option of eventually switching places with your child, as your need for space declines and theirs grows.
Unlike renting out a basement suite, however, a laneway house is considered a separate housing unit for tax purposes which may have implications for your principal residence exemption. Speak with your advisor if you’re considering this option.
Three things to think about before you offer to help
Your heart may tell you giving your kids a hand to enter the real estate market is the right thing to do. But is it a smart decision – for you and them? Here’s what to consider before you step up.
1. Are they ready? While your child may be eager for a place of their own, it doesn’t mean they’re ready to take on home ownership. Will they be able to handle the costs, not only today, but in the future?
The Bank of Canada’s first interest rate hike in seven years announced on July 12 could be an early sign interest rates – and borrowing costs – are headed higher.
That said, mortgage payments aren’t the only challenge. There will be bills for things like utilities, property taxes, home maintenance and insurance. Can they set aside enough money to deal with inevitable emergencies? Avoid leading your kids into a situation where they’ll be spread too thin financially.
2. Will extending a hand hurt your finances? Don’t forget you could spend decades in retirement. Make sure you plan properly so your generosity doesn’t threaten your own financial freedom or security, especially as you age and health-related costs increase.
3. What are the consequences for your estate plan? Choosing to use your wealth to help one child can strain your relationships with other family members. It’s important to clarify your intentions. For example, does your gift count against that child’s inheritance? Do you expect any loan to be forgiven upon your death? Communicating with your loved ones and heirs will go a long way towards eliminating misunderstandings.
When it comes to helping your adult child get into a home they’ll love, the good news is you have choices. But, those options often come with a variety of financial, legal and family considerations.
At BlueShore Financial we’re here to simplify things. We’ll listen to what’s important to you and help you weigh the alternatives, so you can make the best decisions for you and your loved ones. Speak with your advisor to learn more.