The "Bank of Mom and Dad" - What Now?
Saturday Dec 09th, 2017
First time home buyers are usually in need of this type of assistance from their parents, adding to (topping-up) the down payment. The new "Mortgage Stress Test" will likely make this scenario a lot more common. The Real Estate Industry is lobbying to allow parents to dip into their RRSP's to help their children purchase a home. Plus, allowing buyers to access their RRSP's more than the legislated one time. The industry also wants to increase the maximum allowable borrowing amount by $10,000.
Mortgage insurance has become a lot more expensive too so there is a lot of incentive to get past that 20% down payment. Anything less than 20% results in more than an 80% mortgage which is subject to mortgage insurance on top of the mortgage itself. For some parents it’s easily affordable but for others it poses a challenge to come up with this. But it shouldn't be at the risk of using all the parent(s)' savings.
Some parents even consider going into debt to help their children into their first home but is this really practical? When it comes to families, many parents don’t want to disappoint their children - so it becomes an emotional decision to leave a financial investment legacy to their children while they can live to enjoy it with them. With the extremely high cost of housing, adult children often just can’t buy a home without some assistance, however it’s critical to balance this together with what their parents need.
There are other questions parents need to ask themselves before delving into the "Bank of Mom and Dad" Will they outlive their money? What about inflation's impact? Do they have enough set aside to cover their own medical costs associated with debilitating health or long-term care?
Parental financial help is often a gift but would it be better to structure it in the form of a loan in case there are unforeseen retirement costs? If parents become truly comfortable, that they have enough life-time assets, they can always forgive the loan down the road.
Despite the high prices, interest rates are still so low that this is an encouragement for parents to assist their children. Today, half of a mortgage payment goes towards paying the interest and half goes towards the principal whereas not too many years ago it wasn't such an equal ratio in favour of that principal.
When mixing family and money, emotions can run high, so it’s important to clearly define everything along with sage financial advice. Some parents are even selling investments or changing their own home ownership status to free up funds to help their children. It’s crucial to figure out that this won’t impact their own quality of life. Plus, homeownership comes with large financial responsibilities - are their children really ready for them?
Parents should think about putting terms and conditions in writing whether it’s a gift or a loan. It’s just wise protection for both sides of the investment. There can be more than one child in the family. Or what will happen to their investment should there be a divorce or other unforeseen challenges?
Other considerations? If a parent gives cash, is that gift an advance on that child’s inheritance? If it’s a loan, will that loan be forgiven on the parent(s)’ passing, or would it be deducted against what the child will receive from the estate?” These are very important answers to know ahead of time.
It’s wonderful when parents want to and can help their adult children purchase a home, however family discussions to disclose and review all this planning can save many financial misunderstandings and emotional heartache down the road.