It’s no secret that Canadians are increasingly turning to their parents, affectionately known as “the Bank of Mom and Dad”, for assistance with their down payments when buying a home. In fact, about a third of all homebuyers in Canada have turned to their families when it comes time to make a down payment. While most of these people are first-time homebuyers, it’s estimated that close to 10% of people moving to another home have also sought assistance from the Bank of Mom and Dad. With home prices continuing to rise, even for many Canadians who have the means to afford a mortgage, the lump sum required for a down payment is increasingly out of reach. If you are one of the many Canadians who intends to reach out for help from your family when making a down payment on your home, read on for some important information to consider.
What are gifted funds?
The easiest route to take in terms of providing assistance might seem to be gifted funds, which are exactly what they sound like: money given to you with no expectation of repayment. As a home buyer, you are only permitted to use funds gifted by an immediate relative, in other words, by your parents or your siblings.If you want to receive a gift of funds to help with your down payment, you will need to have the following items:
Donor letter: This letter is done on a pre-made template provided by your lender. It must be signed by the donor, and explicitly states that the funds are a gift and not a loan. It should also include the donor’s contact information and relationship to the recipient.
Proof of funds: You and your donor will need to demonstrate that the money being gifted has been transferred into your bank account. You may also need to prove that the source of the funds was indeed your family, depending on the lender.
The biggest advantage of gifting funds is the relative ease of doing so. However, there are some drawbacks that you should consider. Probably the most important of these to keep in mind is that in the event of a divorce, the home will be considered matrimonial property and will be split accordingly. Since the funds used to purchase the home were gifted, there is no recourse to get your parents’ money back, and 50% of the money could well go to your ex-spouse (even if they contributed nothing to the down payment).
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Bank of Mom and Dad
If you want to be able to access the Bank of Mom and Dad with less risk, a loan is likely the better way to go. In order to have the funds considered a loan, you will need to have a loan document drawn up that clearly states that the money in question is a loan and not a gift, and should also include a repayment schedule and terms and conditions (such as consequences for missed payments). Without this loan document, in the event of a breakup or divorce, the funds will be considered a gift and divided up accordingly between you and your ex. Keep in mind that a loan could negatively affect your debt-to-income ratio if it’s too large and/or the repayment schedule is too aggressive, thus complicating your chances of getting approved for a mortgage.
Your parents may not have the cash to either gift or loan you. In this case, a popular option is to take out a second mortgage, typically in the form of a home equity line of credit (HELOC). Again, in this case, it’s critical to have a loan document or promissory note drawn up to ensure that both parties are protected and that the loan is repaid. This also ensures that in the event that the property needs to be sold, your parents will get back at least some, if not all, of the money they loaned you.
Another avenue to consider may be to have your parents co-sign for your mortgage loan. This is a relatively simple way to potentially increase your purchasing power. However, if your parents have a poor credit history or have a lot of debts, it can actually hurt your ability to get approved for a mortgage. And, of course, if you fail to keep up with your mortgage payments or default altogether, your parents’ credit score will also take a hit and they may even be saddled with paying off your mortgage.
The Bottom Line
Ultimately, how you approach this really boils down to your individual circumstances and those of your parents. You’ll want to be sure to consult with your broker or lender, and you may want to consider speaking with a financial advisor as well. While borrowing from the Bank of Mom and Dad to help with your down payment might not be feasible or desirable for everyone, it might just be the right choice for you.
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