With the average price of a detached house at $635,000 in greater Toronto, and $925,000 in greater Vancouver, it is easy to see a challenge for both first and second-time homebuyers.
If you want to help your child with a home purchase, there are a couple of factors to look at. The first is the parenting philosophy of an individual. The second would be the financial strength of the parent. The third might be the financial strength of the child. The fourth might be the strength of a child’s marriage.
Philosophy of the parent
In the past, it was much more likely that parents would say ‘I never had any help buying my first house, so my kid can do it themselves’. Today, with the daunting house prices facing those first and second time home buyers, it leads many parents to a different opinion.
Many parents have personally seen the financial benefits of home ownership. They also see the financial struggle and limited housing options facing many of their children, and have decided to do something to help.
In some cases, helping means a loan with normal interest rates. In some cases it is a loan with lower or no interest. In some cases it is effectively a gift.
Today, we are seeing a general philosophy of parents wanting to help their children with real estate – assuming they have the financial strength.
Do you look at a child with a good job and a decent savings discipline, and help them get a leg up? Or do you let that child fend for themselves because they will likely be OK, but only help out the child that will never be able to afford a home on their own? Do you make sure that all children receive equal benefits? Our general recommendation is to assume you are helping all children equally, regardless of their personal financial strength. After all, as the Smother’s Brothers used to say “Mom always liked you best.” Kids never outgrow that issue and concern. This means that if you think you can help your children with $300,000, and you have 3 children, you better not overextend to the oldest child and then run out for child two and three.
Financial strength of the parent
It is very difficult for a 60-year-old couple to know how generous they can afford to be, without having some form of detailed financial projection that will show the impact of a financial gift or loan. You want to know what would happen if you gift $200,000 to a child? Will that put you in financial trouble in 20 years? What if you make a loan to a child, and they never pay you back? Can you afford that? Unfortunately, family debts are among the most likely to become impaired debts. Regardless of the financial planning and projections, a loan with a modest interest rate is the least likely to be of risk to the parent. Remember, once the gift is made, it is very difficult to unmake it. The financial and emotional stress of a poorly thought out gift can be very difficult for the whole family for years to come.
Financial strength of the child
There are some children (I know it is rare), who don’t want their parent’s help. They want to be able to do it on their own. There are also children who have good jobs and are a good loan risk. This means that if the parents want to lend them money at a standard or low interest rate, it likely doesn’t represent much of a risk for the parent’s financial picture.
If the child’s situation is not in as strong, one of the questions is whether, even with help, the child should be buying real estate? If they get a loan from their parents, will they be able to pay it back? Will it cause family stress? If they receive a financial gift, will they still struggle with paying the mortgage at the bank? Sometimes the best help a parent can give is to advise the child to keep renting (or living at home) rather than buying real estate that they can’t afford.
The strength of a child’s marriage
This is important, as a financial gift will become your child and their spouse’s family property as soon as it is received. We have seen cases, where a parent gifted $400,000 to help buy a house, and six months later the child’s marriage broke up. In this case, the parents just handed their soon to be ex-daughter or son-in-law a $200,000 gift.
The best way to avoid this is to not make a gift at all. Whether it is a standard loan with standard interest rates, or a 0% interest rate, or even a demand loan that isn’t meant to be paid back, the key is to make the financial ‘gift’ in the form of a loan.
If the goal is to make it a gift, we generally tell clients to write up a demand loan note. This says that you are ‘loaning’ $200,000 with no repayment plan. However, you have the right to call the loan at any time. The reason this is important is that technically the child and their spouse owe this money. It is not part of their family property. In the event of a marriage breakup, the parent would demand the loan, and this loan amount would be reduced from the family property.
One way to look at this is that in a best case financial scenario, you will likely be leaving a sizable estate to your children when you pass away. It is usually preferable to not wait until you are gone (and your children might be in their 50s or 60s), if some gifting could have happened earlier. Why not help at a time when your children can use it, and you can see the benefits. Unless your child is single, I would recommend structuring any financial support as a loan.
In a scenario where you may be financially in a position to help, but it isn’t so clear, it is better to be safe and only look at a loan scenario with a clear expectation of repayment. If repayment isn’t so likely, then it is better not to help.
One last thing to keep in mind is that while owning personal real estate is a positive from a tax perspective, and is generally positive from a ‘pride of ownership’ perspective, it may not be the obvious choice in 2013 that it was 40 years ago. In many cases, renting provides greater peace of mind and a higher standard of living, given how large many mortgages are today.
In the end, part of being a parent is knowing when to help and when to stand back.
Ted Rechtshaffen is president and wealth advisor at TriDelta Financial, a boutique wealth management and planning firm.