November 1, 2017

Down Payment Gifts: What New Buyers Need to Know

High real estate prices and new mortgage rules designed to clamp down on risky lending have made it harder than ever for first-time buyers to own a home. So it’s not surprising to hear that cash-strapped millennials are accepting increasing amounts of financial help from parents in the form of “gifted” down payments.

People generally receive inheritances later in life, when they’re already financially established. But boomers, particularly those living in major urban centres, are increasingly using gifts to help their children climb on to the property ladder. Eighteen per cent of first-time home buyers say they received money for a down payment from a family member, according to a survey conducted by the Canada Mortgage and Housing Corporation (CMHC) this summer.

Down Payment Gifts on the Rise

But, while likely grateful, they weren’t necessarily happy with the arrangement. “First-time buyers who received a gift from family as part of their down payment were less comfortable than others with their current level of mortgage debt,” the agency reports — probably due to the fact that “they were less likely to have other assets to supplement their needs should they run into financial trouble.”

And that was before they learned that Ottawa now plans to move forward with regulations establishing a new minimum mortgage qualifying rate, or “stress test,” for even well-heeled buyers able to come up with a down payment of more than 20 per cent of a home’s value. Previously, limits set by the Office of the Superintendent of Financial Institutions (OSFI) only applied to insured mortgages under that 20-per- cent threshold.

The new stress test — designed to predict whether homeowners could handle their debt if interest rates or their personal finance situation were to change — means borrowers would be assessed at either the five-year average posted rate, or 2 per cent higher than their actual mortgage rate — whichever is higher. This means many first-time buyers may be looking for even more help from the “bank of mom and dad” since this increased hurdle effectively reduces most home buyers’ affordability significantly.

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What Young Home Buyers Need to Know

The first rule of accepting a gifted down payment is that it has to come from an immediate relative with no strings attached. More importantly, it’s also supposed to be a bequest that never has to be repaid, something that the family member gifting the money has to confirm in writing.

This is not about parents simplify promising to step up and help. Gift letters need to outline the amount of the gift, the specific recipient, the relative’s relationship to that recipient, and the fact that the gift isn’t subject to any repayment schedule. The money will be expected to be deposited into the buyer’s account and should exactly match the amount shown on the gift letter. It’s not unusual for lenders to verify bank records to confirm the source and amount of funds being transferred.

Other Ways Parents Might Help

Rather than providing an outright gift, some parents or relatives may prefer to provide the money for a down payment by means of a loan. But lenders frown on this practice since it actually increases borrowers’ loan-to-income ratios, making them a poorer risk. This is becoming even more of an issue since OSFI is now insisting that lenders enhance their loan-to-value measurement and employ more stringent LTV ratio limits that reflect the underlying risk of high-flying markets like Vancouver and Toronto.

Co-signing the mortgage is another option. The trouble here is that co-signers are responsible for the full mortgage balance owing. Well-meaning parents may think they’re just helping the kids out, but as co-signer they’re responsible for everything, including any condo fees, insurance and taxes.

Another caveat for gift-giving relatives: If a couple is buying a home jointly, you may want to specify in the letter that the gift is intended for the use of your child or grandchild and support this with some sort of pre-nuptial agreement. Otherwise, if the relationship fails, it may be considered joint property and split evenly between the two parties – likely not what you originally had in mind.