A sign advertises a new home for sale in Carleton Place, Ont. on Tuesday, March 17, 2015. The Bank of Montreal is cutting its posted five-year fixed mortgage rate, a move that experts say could spur other banks to slash their rates as well as the spring real estate season begins.Sean Kilpatrick/The Canadian Press
It's not unusual in today's economy for parents to help adult children buy their first homes. But it's essential that parents put their own future needs first, before throwing open the vault at "the bank of mom and dad," experts say.
Most first-time homebuyers are in the 25-to-34 age range, and the most common form of parental assistance, for those who receive such help, is a top-up of the down payment, said Will Dunning, chief economist at the Canadian Association of Accredited Mortgage Professionals.
"Mortgage insurance has become a lot more expensive, so there is a lot of incentive to get past that 20 per cent down payment," he said. Lenders typically demand mortgage insurance if the down payment is less than 20 per cent of the purchase price.
"For some [parents] it's easily affordable, but for others it would be more challenging. You don't want to devote all your savings to helping your kids get into a house," Mr. Dunning said.
Even more worrisome is when parents go into debt in order to give their adult children a foothold in the housing market, said Peter Bowen, vice-president, tax and retirement research, at Fidelity Investments Canada ULC.
But when it comes to family finances, logic does not always prevail. A gift or loan to subsidize the purchase of a home is an emotional investment as well as a financial one for parents who want to leave a legacy to their children while they are still alive, Mr. Bowen said.
"Canadian housing costs seem pretty high these days, and often adult children cannot buy a home without other assistance," he said. "That's where the parents come in, but that needs to be balanced with the parents' needs."
Even if parents think they can afford to be generous now, they must consider "longevity risk," he said. Will they outlive their money? What will inflation do to their savings? Do they have enough set aside to cover the medical costs associated with a debilitating health event or long-term care?
While parental assistance often comes in gift form, it's more prudent to structure the arrangement as a loan in case unforeseen costs crop up in retirement. "The loan can always be forgiven at some point if the parents become comfortable that they have enough assets to last the rest of their lives," Mr. Bowen said.
One reason parents want to help their children get into the housing market now – despite high prices in some areas – is that interest rates are so low, Mr. Dunning said.
"At today's interest rates, half of your mortgage payment is [paying off] the principal," he said. "It wasn't that long ago that only a quarter of the payment was principal."
In the hot Vancouver market, it's becoming "almost universal" for parents to help their children buy their first homes, said Chris Catliff, president and chief executive officer of Vancouver-based financial services firm BlueShore Financial. "But when you mix family with money, emotions can run high, so clearly defined expectations along with advice from your financial adviser are essential."
BlueShore advises parents against being generous to a fault. "If you are 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 are about to give away," the firm advises. Parents should also assess their child's readiness to become a homeowner. It's a big financial responsibility.
Whether the arrangement takes the form of a gift or a loan, any terms or conditions should be put in writing, Mr. Bowen said. This is especially important when there is more than one adult child in the family, or to protect the parents' investment if they have lent money to a child whose marriage subsequently breaks up.
Mr. Catliff's firm also advises parents to clarify their intentions through an 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 be deducted against what the child will receive from your estate?"
Communicating your plans and spelling them out in your will can save misunderstandings and hard feelings later, he said.