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Robert McLister: It's common for first-time home buyers to seek help from family, but getting it wrong can be costly
Published on February 16, 2024 • Last updated 19 hours ago • 5 minutes reading
Nearly three in 10 first-time buyers ask their families for down payment assistance, but there are pros and cons to asking family for money. Photo by Getty Images/iStockphoto
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The surge in activity in the housing market this winter has led some, including economists at the Royal Bank of Canada, to question whether the end of Canada's housing correction is finally at hand.
That will undoubtedly increase the sense of urgency for potential homebuyers, especially young buyers, who see the writing on the wall: not enough houses, high immigration, rising incomes and falling interest rates – all historically fueling housing prices.
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Even as Canada flirts with a recession, qualified would-be homebuyers must ask themselves whether they can afford to bet that home values won't be higher in 12 months.
But what if the down payment balance in your piggy bank runs out? So how do you get on the real estate ladder?
One possibility is to have generous relatives. According to previous research from the Canadian Imperial Bank of Commerce, nearly three in 10 first-time buyers use their families for the down payment.
Assuming you don't have another source for the down payment, a family contribution offers five potential benefits.
Interest savings: The larger your down payment, the smaller your mortgage and the less interest you pay.
Purchasing power: A larger down payment helps people afford more home.
Savings on default insurance: If family allowance helps you save 20 percent, you can say goodbye to standard insurance premiums. On a $500,000 home, that's up to $20,710 in savings – or more if you include insurance in the mortgage.
Purchase price savings: Having family support help you shop before price increases can save you tens of thousands of dollars. Consider that home values increase by an average of 5.78 percent over 12-month periods, according to 43 years of national price data from the Canadian Real Estate Association. The range ranged from a 42 percent 12-month gain to a 19 percent 12-month loss. If prices rise by even an average amount while you wait to make a down payment the old-fashioned way – by saving – that could cost you $28,900 in lost value on a property worth $20,000 in just one year Cost $500,000, minus any savings from rent. That's more than most people can save in a year.
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More secure consent: Let's say your debt-to-income ratio is just below the lender's limits and you decide to delay the purchase for a year. If prices rise by an average of 5.78 percent, this could push your debt ratio beyond lender limits. The result: You may no longer qualify or have to pay much more for a mortgage without top-notch credit.
Let's say you decide to ask your family for a down payment. What happens if they give you the money on the condition that they get it back?
Well, it's not a gift. It is a loan and all major lenders require down payment loans to be disclosed.
Most lenders are okay with free down payments. On the other hand, loans come with a tighter leash.
Opt for a fail-safe mortgage through Sagen or Canada Guaranty and down payment loans are acceptable. The insurance premium is half a percentage point higher than normal, but that's not a big problem.
The catch is that with unsecured down payment loans, lenders require a monthly payment – typically three percent of the loan amount – even if your family doesn't require payments. This increases your debt-to-income ratio and reduces your maximum mortgage amount.
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To get around this limitation or to satisfy a family member who wants their money back, some borrowers cheat and tell their broker/lender that the borrowed funds are a “gift.”
Others deposit family money into their bank account three months before applying for a mortgage and then spend it as personal savings. (Lenders require a one- to three-month statement to document where your down payment money came from.)
Stay away from these taboos. Not only does a misrepresentation constitute down payment fraud, but if you get caught, the lender can theoretically foreclose the mortgage and take other unpleasant actions.
Undisclosed down payment loans place a financial burden on the home buyer and pose a risk to both the borrower and the lender, although the extent of this is disputed.
“I wouldn't be surprised if a lot of people who get a down payment secretly pay back their parents,” says Dan Eisner, founder and CEO of True North Mortgage and Think Financial. “As a lender, we do not see this as a critical risk.”
“Even if the parents secretly register a second mortgage after graduation (to protect their down payment loan), what are the chances that the parents will foreclose on their child?” he asks.
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“If anything, it shows that the borrower has a contingency plan in place if things go wrong. If a parent gave them a gift of $40,000, the borrower can likely turn to that parent if they need help making their mortgage payments.”
More about down payment gifts and loans
If you're planning a family-funded jump onto the real estate ladder, keep these seven things in mind.
1. When it comes to “gifts,” borrowers and donors in the family usually have to sign the lender’s gift letter. This certifies that the deposit is non-refundable.
2. For traditional mortgages, most lenders require down payments from a parent, grandparent, child or sibling. If you are accepting funds from your third cousin who has already been removed twice, contact a mortgage broker for additional options.
3. If your family's lender is concerned that the generous down payment may be divided in a loving separation, contact an attorney. You can specify in a cohabitation agreement or a prenuptial agreement where the down payment will go in the event of a separation.
4. If necessary, an agent can recommend uninsured lenders who will allow your relatives to register a second mortgage on the property. This ensures that the down payment loan will be paid back when the property is sold. The second mortgage can be interest-bearing or non-interest-bearing, with or without installments.
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5. Most lenders don't allow gifted down payments on uninsured second homes or non-owner-occupied rental properties, but agents know the exceptions.
6. Family members sometimes decide to take ownership (e.g. taking one percent of the shares). This way, their down payment funds are not considered a gift. However, keep in mind that this leaves the family donor responsible for the mortgage if the other buyers default.
7. Some lenders have a policy prohibiting gifts from family members in certain countries such as China or India.
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In short, calling Family Fund for your down payment can save you a lot of money and make mortgage approval easier. Make sure you carefully go over the distinction between a loan and a gift. Otherwise, you may find yourself in a minefield of fiscal stress.
Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.
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