Will you give your adult children money to help them buy a home?
Recently, a report from CIBC Capital Markets came out that parents gave their adult kids more than $10 billion to buy homes in the past year. For first-time young home buyers in Toronto, that bit of help averaged around $130,000. For those in Vancouver, the average was $180,000. Not every city is as outrageously expensive as Toronto or Vancouver, but the impact of ultra-low interest rates and the increasing viability of working from home, among other things, is pushing home prices steadily higher. The result is that even high-earning young adults are hard-pressed to come up with a satisfactory down payment. And those that do are shackled to mortgage debt that they may find difficult to pay off before they are retired.
Enter Parents
Most parents want to see their children become successful in life. They want to see them able to live independently of their parents, to form a household just as they did when they were young adults. For many, household formation is almost synonymous with home ownership. Recognizing that their wealth is derived from the same sources that make home ownership difficult for their children, parents choose to use some of their wealth to make their children’s home ownership possible.
Ways Parents Can Provide Assistance
A Gift
This is straightforward. The parents give their children money to enable them to buy a house. If they are of substantial means and/or the house has a relatively modest cost, the gift can be the full purchase of the home. Alternatively, the gift can be all or a portion of the down payment. This latter option assumes that the adult children have sufficient steady income to afford the mortgage and other regular costs of home ownership. Another option is to pay the monthly mortgage.
A Loan
Parents may not be able to forgo the capital they would lose in the case of a gift, but if they don’t need it immediately, they may be willing to lend money to their children.
A Loan with Interest
If a loan from parents is to be a benefit for the children, the interest charge would probably be at a rate that is lower than what the children would pay through a regular mortgage. Perhaps the parents might ask for the rate they get on a savings account or at a certain rate below that of their children’s mortgage.
A Loan without Interest
With interest rates so low these days, an interest-free loan may not be that big a deal. But it’s not nothing. It means the parents are not earning anything on the money they have loaned.
Co-Sign the Mortgage
In this case, parents are lending their creditworthiness to their children. It helps them qualify for a mortgage that they might not otherwise qualify for.
Problems with a Gift or Loan
Gift
Although no one goes into a marriage anticipating that that there will be a divorce, a gift means that you have lost control of the asset. The matrimonial home is generally divided 50/50 between the divorcing spouses, meaning that half your gift could effectively leave your family.
Loan
In general, a loan is provided with the expectation that the principal will be repaid over time, with interest included. Even if the loan is interest-free, if you are counting on the return of the money to help fund your retirement, it would become quite awkward if your children refuse, or for whatever reason become unable, to continue repaying the loan. A financial institution will follow its standard procedures and either foreclose or begin the power of sale process. Parents might find it difficult to take the same steps for fear of permanent estrangement.
If the form of your loan involves lending your creditworthiness by co-signing the mortgage, if your child defaults on the mortgage, you as the co-signor become liable for the mortgage payments. Furthermore, by co-signing, your name is added on to the title of the property. If a liability issue were to arise, you could be legally “on the hook” for any judgment.
Parents, Can You Afford It?
Among the parents who gifted money to their children to help buy a house, Benjamin Tal of CIBC World Markets estimated that about 5.5% of parents went into debt to finance the gift. That is not a huge proportion, but it does raise alarms. While it feels unfair that your own children cannot afford to purchase a home in the same city or neighbourhood that you were raised in, undermining your own ability to retire by effectively passing on your estate while you still need to use the assets concerns me.
The Canadian Focus on Home Ownership
Data from Statistics Canada and other sources indicates that home ownership rates in Canada are significant at approximately 68% versus 42% in Switzerland, 51% in Germany, or 61% in Japan to name three different developed countries. This is not to say that there are not other countries with higher degrees of home ownership, but there are peer “developed world” countries that do not automatically assume that home ownership is a fundamental goal of entering the adult world.
Now, I say this as a homeowner, but I am concerned about young adults – and their parents – so desperate to get into the housing market for fear of missing out that they become “house poor” as a result. In earlier decades, households would become house poor, too, but in those days, it was because of high interest rates not because of high home prices.
Renting
Renting is not the end of the world. While home ownership is touted as a good way to institute a forced savings program because the mortgage must be paid, I am concerned about the concentration of household wealth in a single asset that is arguably, in some parts of the country at least, dramatically overpriced. One of the key rules in investing is to diversify your assets. If everything you own is tied up in your house, diversification does not exist, meaning the risk is multiplied.
Renting gives the non-homeowner a chance to reduce their financial risk by spreading their ownership over a variety of assets potentially spread out around the world. Renting also provides the renter more freedom to move for employment opportunities; reducing the frictions imposed by owning.
I don’t want to undermine the idea of home ownership, but reducing your assets for the sake of your children may not be the the best thing to do, especially if it means your financial future is permanently impaired.
This is the 122nd blog post for Russ Writes.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.