Richard Yasinski CFP
With our children renting university accommodations or graduated and settled down in their careers, I often get asked about how best to help get them into their first home. A home can be a great savings and investment strategy but challenging (and costly if they buy wrong) for first time home owners to purchase without help. Here are a few things you need to consider before making the decision to help your child buy their first home and how you might do it.
Firstly, “Does it make sense for your children to own a home at this time?” My daughter started working in Ottawa with the best of intensions of settling here – rented an apartment, bought furniture and was beginning to save for a home. Life happened and she’s now a Wild Fire Ranger in Alberta living in a camp all summer – and guess where all her furniture is! With the transient nature of employment, you need to be very comfortable your son or daughter have a high probability of staying put. Even then you need to be prepared with a plan B – they move out of town within a few years for work and your investment may need to become a rental. It may be more appropriate to renovate the basement for your children to live if job security is an issue. Buying a home and having to sell too soon is costly.
Having considered these things, and confident your son and daughter, along with your help, will buy the most appropriate home in the right location, then how might you do this?
Most first time home owners need help with the down payment and I recommend striving for a minimum 20% down as this eliminates the need for a CMHC insured mortgage which just adds to the cost. .
You could simply “gift” the money to your child. If your child plans on living in the home alone (and renting to friends – even better) and qualifies for a mortgage – this would be the simplest approach. However, once they get into a live in relationship and that relationship breaks down, the home could be considered matrimonial assets and the equity divided – including your gift. A pre-nuptial agreement is awkward, messy and not likely.
You could loan the down payment money to your children and collect interest. A documented loan must be legally repaid so you have a better chance of protecting your money. But the lenders would want to know the details of the repayment schedule which could cause an issue with the mortgage and you may end up having to be guarantor. Given interest payments aren’t high enough to matter much and are taxable, there is another way to loan the money,.
Another approach that protects your money and is most tax and investment efficient is setting up a demand loan with your children. You offer your children an interest free demand loan based on a percentage of the purchase price – like 20%, the down payment. You can request repayment of the loan based on the same percentage of the future sale price of the home. Your child applies to a bank or mortgage broker for a mortgage using your loan as a down payment. The lenders “should” be okay if the demand loan is documented and clearly states no payments required until sold, you should find a lender to accept this. Your demand loan may have to be positioned as a second in line to the mortgage as the lender will want to be first in line. The amount of the loan is based on size of the mortgage your child can qualify for plus all the other costs of home ownership.
If we assume you loaned them 20% of the purchase price, you could have both your names (joint with right of survivorship) on title of the property and complete a simple document confirming the arrangement (you would want to consult with a lawyer for it to be legal). You can include some conditions such as, no monthly payment required, the home must be in the province where you live – which is an outright bribe allowing more frequent visits, the loan could be secured by a second mortgage on the home (which requires a lawyer to put in place) – this secures your investment in the event of a potential relationship breakup. You can also limit the loan for a specific period, say 10 years, or if the house is sold, when it must be paid back – which of course you can decide to change if circumstances dictate. When sold, you would receive 20% of the sale price. The gain on your initial investment would be a capital gain, 50% of which would be taxable at your marginal tax rate at the time.
Along with protecting your money this last approach is a mutually beneficial arrangement and doesn’t look like a hand out but a hand up to your children. Of course, when you do buy a home, make sure you get the important renovations done by a RenoMark Contractor.
“Richard is an independent Financial Life Planner in practice in Ottawa since 1996”