More and more Canadian homebuyers are turning to “the Bank of Mom and Dad” for help with their down payments or financing. With house prices continuously on the rise, approximately 1/3 of first-time homebuyers are turning to their families for financial help.
What does this mean for first-time homebuyers? For those fortunate enough to have parents with the financial means to help, it can simplify the process of purchasing your first home. However, it’s important to understand that this option may not be available to everyone, and that there are still many other avenues you can explore to purchase your first home.
So, here’s what we do know.
The increasing rates aren’t just affecting first-time homebuyers. Even those moving from one house to another are turning to the Bank of Mom and Dad for help—they can afford the mortgage, but the down payment is unobtainable on their own.
But is this really a good idea? If you’re thinking about asking your family for help with the down payment on a home, both you and your parents should keep reading.
The Bank of Mom and Dad: How it Works
Canadian house prices have gone up by 25% in the last year alone. Mortgage qualifying rates are also on the rise—4.79% to 5.25%. This isn’t great news for you Millennials or Gen Z’ers.
But this is where the Bank of Mom and Dad comes in handy. Nearly half of these generations have received money from Mom and Dad to put towards buying their first home.
How does it work? Mom and Dad have a few options:
- They can gift you money
- They can borrow you money
- They can apply for a second mortgage
- They can co-sign for your loan
Gifted Funds
The rule here is, homebuyers can use gifted funds toward their down payment, only if the money is gifted by an immediate family member such as parents or siblings. So, what are gifted funds?
Gifted funds are any money you receive without the expectation of having to pay it back. Bonus: In Canada, you don’t pay tax on gifts.
There are a few things you’ll need to include when applying for a mortgage with gifted funds:
- A donor letter: Ask your lender for a template for the ones they use. The letter will need to be signed by the family member donating the money and must clearly state their relationship to you, their contact information, and a statement saying that the money is a gift, not a loan
- Proof of funds: You’ll need to prove that your donor has transferred the money to your bank account. Some lenders may ask for proof showing that the money came from an immediate family member
- Any special circumstances like whether the money is part of an inheritance
As easy as gifted funds sound, the home will be considered matrimonial property. This gives you one big disadvantage to think about—when using gifted funds toward your down payment, you won’t be able to recoup the gifted money if you and your spouse should ever separate.
Because the house will be split equally, 50% of your parents’ money will end up going into your ex’s pocket. Yes, even if they contributed nothing toward the down payment.
Loans
The less risky way to use funds from the Bank of Mom and Dad is to draw up a loan agreement. This will protect you and your parents in the event of a separation. Without the loan document, the borrowed funds will be considered a gift and will be divided respectively.
The loan agreement is done exactly opposite of the donor letter. The loan document must clearly show that the funds are being borrowed, not gifted. Include specific terms and conditions of the loan like your agreed upon repayment schedule and the penalties for missing payments.
The disadvantage of using the Bank of Mom and Dad for a loan is having it impinge upon your debt-to-income ratio. Borrowing a large amount for your down payment can interfere with being approved for your mortgage.
Taking a Second Mortgage
If there’s no extra cash in the Bank of Mom and Dad, your parents will need to apply for a home equity line of credit (HELOC). This type of loan puts a second mortgage on their house.
If you and your parents decide to go this route, this is still a loan to you, so it’s important to draw up a loan agreement. This will protect you and your parents in the event of a separation.
Co-signing Your Loan
If taking a large amount of money from the Bank of Mom and Dad isn’t sitting right with you, or you’re not wanting them to take out a second mortgage, you have another option: they can co-sign for your loan.
Word of warning: If your parents have a lot of debt or bad credit history, this can affect your mortgage approval.
If their credit is good and it helps you to get approved, it’s your responsibility to keep up on the mortgage payments. If you miss payments or stop paying all together, your parents become financially responsible for your home. Defaulting on payments will negatively affect both yours and your parents’ credit score.
Still Unsure About Using the Bank of Mom and Dad?
Although taking money from the Bank of Mom and Dad has become a popular trend, you may still be on the fence on whether it’s the right option for you.
If you’re hesitant about the risks involved with turning to the Bank of Mom and Dad, I can help answer those lingering questions. Book a meeting with me today.
Hi, I’m Joel, a real estate professional based in Toronto.
My approach is simple—I put you first. I believe in open communication, total transparency, and meaningful results. I’ll guide you through the real estate process, market values, and always keep the focus on you—and your needs.