Bank of Mom and Dad Helping Their Children Buy a Home

by Richard Bell

For many young people thinking of buying a home, which in the urban centers means a condo, the cost of home ownership is simply out of reach. The provincial government provides some assistance by providing an exemption from property transfer tax for first time buyers and the federal government provides some assistance by a regime of mortgage insurance enabling buyers to borrow up to 95% and allowing up to $25,000 per owner to be withdrawn from RRSPs tax free.

However, the challenge for many is raising the down payment or making the monthly mortgage payments or both. So increasingly, to the rescue comes the Bank of Mom and Dad.

Mom and Dad are often in a financial position to help their children get a start. There are a number of different options for parents to help.

First, a child may have enough of a down payment but does not satisfy the Gross Debt Service (“GDS”) ratio or Total Debt Service (“TDS”) ratio to meet the banks’ requirements for a mortgage. This is a bit complicated but here is a short description of these ratios. To calculate the GDS, lenders look at total housing costs which include monthly mortgage payments, property taxes and heating and determine what percentage that represents of gross monthly income for the household. This ratio should be 32% or less of the gross household income. For TDS, the lender includes most other monthly expenses and the TDS ratio should not be more than 40% of the gross monthly income for the household.

In this situation the parents may simply agree to guarantee the loan although most lenders will require the parents go on title to the property as owners. Although there are some exceptions the lenders will calculate the GDS and TDS including the parents’ financial information. Parents’ going on title raises some concerns as to the impact on the first time buyers’ exemption under Property Transfer Tax and the potential for the parents to be charged a capital gain upon the subsequent sale of the property as the property was not their principal residence. To the rescue comes the legal advisor.

Where the lender requires the parents to be on title the legal advisor will likely recommend the parents hold a 1% interest in the property. A child entitled to claim the first time buyer exemption would then get the benefit of 99% of the exemption. To deal with the potential exposure to capital gains the legal advisor will likely recommend that the parents sign a trust declaration stating that they hold the 1% interest “in trust” for their child; which means the property really belongs to the child and the parents are only on title to meet the requirements of the lender.

Second, parents may provide some or all of the down payment by way of a gift. The lenders will recognize the down payment as belonging to the child if the parents execute a gift letter stating that the funds are an outright gift to their child and there is no obligation on the child to repay the amount.

Third, parents may provide a gift to satisfy the down payment requirement that must come from the assets of the child as well as additional funds over and above the minimum down payment required by the lender. In this situation the parents may be concerned about future claims under the Family Law Act whereby the child’s spouse could claim a 50% interest in the funds that the parents provided over and above the amount intended to be a gift. Often parents will want to protect these additional funds from a claim by registering a second mortgage against the property. Mortgages contain a provision requiring the consent of the lender in the event the owners of the property are granting additional mortgage security. So where parents wish to register a second mortgage they must obtain the consent of the lender. If the lender does not consent the parents could have the child and child’s spouse execute a promissory note which is not registered against the property. Normally the mortgage or promissory note is payable on demand and is interest free. If interest is included in the loan then the parents must account for tax on interest income regardless of whether or not they receive the interest.

Fourth, parents may be in a financial position to truly be the Bank of Mom and Dad and provide all funds necessary to purchase the property. In this situation they may want to register a mortgage to protect against a future claim under the Family Law Act. And again the mortgage may simply be payable on demand with or without interest and principal payments.

A caution for parents is to consider the impact of a loan to a child on their estate plan. If the parents have other children or other beneficiaries in their Wills the outstanding demand loan needs to be considered. If one child has received a disproportionate benefit by a loan to buy property, is the loan simply forgiven at the time of the parents’ passing or is there an adjustment to ensure that each child is treated fairly.

Best Advice: As with all things complicated you should always talk to your professional advisor.