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First-time homebuyers’ guide for you (and your parents)

Historically low interest rates and rising real estate prices have created a buying frenzy across the Canadian housing market. Many first-time homebuyers, as well as those wanting to upgrade their homes, are seeking help from their parents to cover down payments as they jump into the real estate fray.

“Despite being in her 30s and having a great job, there was no way our daughter could afford a house in Toronto, so my husband and I decided to give her an advance on her inheritance to help cover the cost,” explains Beth, a Newport client. “We were fortunate to be able to help her without really impacting our retirement savings.”

But parents’ eagerness to assist and their adult children’s willingness to take on extraordinary debt can create cross-generational financial challenges. Home price inflation is making it harder even for wealthy parents to help kids cover down payments, especially when they have multiple children.

“Many of our clients have children who are getting to the home-buying stage of life,” explains Newport Co-Founder and Chief Wealth Management Officer David Lloyd. “Over the past five to 10 years, parents have been helping them with condo purchases; now their kids are looking to upgrade to a house that requires more money, and they may not be in a position to get traditional financing.”

According to the National Bank of Canada’s Housing Affordability Monitor, Canadians are experiencing the sharpest decline in affordability in over two years. In the first quarter of 2021 the median price of a non-condo home in Toronto topped $1 million, requiring a staggering 278 months to save the necessary 20 per cent down payment based on a qualifying annual household income of $172,000 and a saving rate of 10 per cent. In Vancouver—where the median cost of a non-condo home is slightly more than $1.1 million—it would take 317 months based on a qualifying household annual income of $193,000 to make a purchase.

With affordability waning, buyers are having to weigh the financial rationale of wading into an overheated market, not to mention the financial consequences of borrowing from the bank of mom and dad. At the same time, their parents are paying more attention than ever to a range of financial factors before chipping in to help out.

Here’s what to keep in mind if you’re helping your adult kids take a step onto (or up) the Canadian real estate ladder, buying a first home or upgrading.

Tough conversations for parents

Deciding whether to contribute money so that an adult child can purchase a home is about much more than the desire to help, Lloyd notes. Not only are your child’s financial success and happiness potentially at play, but also your long-term financial stability.

“We’re increasingly working with Newport families to help them determine whether a property is affordable, to properly structure a loan or a gift for their kids when providing financial assistance is possible, and to consider all of the risks and opportunities before a purchase is made,” Lloyd says. “Parents need to go through a comprehensive financial planning exercise to determine how much help is affordable based on their net worth. In some cases, children might need to find financing elsewhere.”

Lloyd notes that what’s very important in this scenario is communication. Parents need to have a very frank conversation with their children if they’re providing them with financial assistance to buy a home. What strings are attached to the money, if any? That could involve some discussions that are uncomfortable, yet necessary.

Parents also need to understand that banks are tightening rules around down payments. In many cases, lenders want to confirm that assistance from a parent is a gift and not a loan, an important distinction that could alter the support equation from the parent’s perspective.

Christine Buemann, a mortgage broker based in Prince George, B.C., says that some lenders are requiring gift recipients to sign a letter certifying that a down payment is not repayable to the giftor (who typically must be an immediate family member), while also potentially requiring information about the giftor’s personal finances to confirm that the funds are readily available, along with the source of their income or wealth.

Leveraging the support of your portfolio manager and the rest of your financial advisory team can help clarify mortgage support options and the best strategy to help your children with a down payment—or not, if doing so might compromise your own finances.

In other cases, helping your child with a down payment could even be a highly effective estate planning strategy to transfer wealth across generations.

“Our conversation is typically with the parent going through the analysis where the child is looking for mortgage assistance and whether that is advisable—or potentially even financially beneficial,” Lloyd explains. “If not, we’ll outline potential alternative approaches.”

Timing is everything

If it makes sense to help your kids with a down payment, but you have a fully invested portfolio and need to free cash, there may be several alternatives for you to consider. If you do need to sell assets, doing so may realize capital gains—and create a potentially significant tax liability. Look to sell investments with losses or those with minimal capital gains. Also, capital gains could be offset with losses carried forward from previous years. If you own multiple income properties, one could potentially be sold to cover the down payment cost.

As you consider all of the options, Lloyd’s advice is to work with your portfolio manager to assess the best strategy to liquidate those assets. That could involve planning over several years, forecasting, carefully managing assets and working to ensure that whatever financial aid you provide to your kids doesn’t end up costing you money at the same time.

What about if you have several children, reaching life milestones at different times—and in vastly different real estate market conditions?

Timing can be critical here, too. If you have multiple children buying at different times, the assistance you provided one child 10 years ago won’t go as far in today’s home buying dollars. Assessing how to treat your children fairly can be the most difficult part of all. These are all important points to consider with your portfolio manager’s help.

The legal consequences of your child’s relationship

Helping an adult child with a mortgage down payment can have major legal implications if the purchase is being made with their partner, or a partner moves in after the purchase is made with the parents’ help.

Breaking up is hard to do—and it’s worse when a parent and their child’s partner are now financially tied through real estate.

“Adults are getting married later in life than their parents and a lot of couples are buying houses when they’re single and their significant other is moving in,” Newport Portfolio Manager Caitlin Chapman points out. “You need to protect yourself as a buyer, and so do parents if they’re gifting or lending money to their child.”

She says those conversations can create tensions and trust issues in families if the potential stability or longevity of relationships is called into question.

As Michael, a Newport client, explained: “We made sure that we had an agreement in place to get our family’s money out of our son’s property if he broke up with his girlfriend. They’re now happily married so it all ended well, but we knew we needed to mitigate that risk—just in case.”

Due to tightening lending rules, some parents are taking an equity interest in their child’s home, but that can also get messy. What happens when the house sells for a gain? Do the parents get paid out, or should the profits be rolled into their child’s next house? How are profits split if an ex-partner is involved?

“The financial dynamics are vastly different in every household,” Buemann says. She often sees parents gift, rather than lend money to avoid bank and legal headaches. At other times they’ll get creative, helping to pay off an adult child’s debt to help them qualify for a mortgage. “I try to involve the parents as much as I can to ensure they’re comfortable with the process,” Buemann adds.

Buemann often advises clients not to co-sign a mortgage for their adult children if they can avoid it. Why? If they or their partner can’t cover payments, it will negatively impact the parents’ credit score, potentially affecting their own ability to obtain home or business loans.

Are you the first-time buyer or upgrading your home? A financial stress test is in order

So, what if you’re the buyer looking to purchase your first home or upgrade—perhaps if a baby is on the way or you simply want to move up the real estate ladder?

Chapman cautions buyers and their families to avoid falling prey to FOMO (or ‘fear of missing out’).

“We’ve all heard the stories of wild bidding wars with people overpaying for homes,” Chapman says. “I have clients who are attending open houses saying that they are filled almost exclusively with young buyers who have their parents with them.”

She notes that while it’s natural for 20- and 30-somethings to seek out larger dwellings to accommodate new additions to the family, buyers need to carefully consider how overpaying for a home could impact their long-term ability to build and grow wealth.

Then there’s the issue of potential interest rate increases on the horizon, which could make monthly mortgage carrying costs unmanageable.

Her advice is to stress-test your finances as part of a fulsome financial planning exercise, looking at the impact of everything from mortgage rate hikes to the temporary loss of employment or even a maternity leave dip in salary.

Then consider all the options. For example, a variable mortgage might make more sense than a traditional five-year fixed rate mortgage, at least in the short term. Maybe it’s better to forego purchasing altogether and rent while building an investment portfolio.

“It all comes down to affordability,” Chapman says. “Your realtor or bank may encourage you to spend as much as possible on a house, but you don’t want to be house poor or over-invested in real estate.”

For help in assessing the affordability of assisting your adult child with a property purchase—or to find out more about planning for a first-time home purchase or update—contact your Newport Portfolio Manager today.