Child's Investment: Building A Home With Mortgage Smarts

There are several ways to help your child buy a home, including gifting them cash for a down payment, co-signing a loan, providing the mortgage, or taking out a joint loan with them.

One option is to buy a home outright in your name and rent or give it to your child. This can be done by purchasing a multi-unit property or a place big enough for roommates to offset the cost. You can also buy a home with your child as co-borrowers, which may help you qualify for more competitive terms.

Another option is to finance your child's home purchase and provide them with a mortgage from your own funds. A mortgage servicer can help properly structure the loan and its payment terms.

It's important to carefully consider all your options and consult a financial professional to guide you through the process of helping your child buy their first home.

Gifting your child the money for a down payment

Tax Requirements

In 2024, you can gift up to $18,000 (or $36,000 for a married couple) per recipient without incurring gift tax liability. This is known as the annual gift tax exclusion. If you're gifting more than this amount, you may need to consult a tax advisor to understand the potential tax implications. It's important to note that the gift tax is paid by the person donating the money, not the recipient.

Documentation Requirements

When gifting money for a down payment, you'll typically need to provide a gift letter that includes the following information:

• Donor's name and relationship to the recipient
• Donor's mailing address and contact information
• Amount of the gift funds
• Confirmation that the gift does not need to be repaid

Additionally, the lender may require additional documentation, such as bank statements or deposit slips, to verify the source of the gift funds. It's always a good idea to maintain a paper trail and keep records of all transactions.

Other Considerations

Before deciding to gift your child money for a down payment, it's important to consider your own financial situation and ensure that you can comfortably make the gift without sacrificing your retirement or other financial goals. Consult with a financial advisor or tax professional to understand the full implications of the gift on your finances.

Alternative Options

If you're unable or unwilling to gift the funds for a down payment, there are alternative ways to help your child with their home purchase:

• Gift closing costs: Closing costs can range from 3% to 5% of the loan cost, which may be a more affordable option for you.
• Find down payment assistance: Help your child search for down payment assistance programs, grants, or forgivable loans.
• Co-sign the mortgage application: By co-signing, you can boost your child's chances of securing financing, but keep in mind that you'll be responsible for the payments if your child can't make them.
• Help with the upfront costs: Offer to cover some of the upfront costs associated with homebuying, such as inspection fees or moving costs.

Co-signing a mortgage with your child

Understanding the Role of a Co-signer

A co-signer, also known as a non-occupant co-borrower, is someone who is added to the mortgage application and other loan documents, promising responsibility for the loan. This means that if your child falls behind on payments, you will be legally responsible for covering the debt. It's important to remember that even though you are guaranteeing the debt, you won't have any rights to the property.

Financial Considerations

Before agreeing to co-sign a mortgage for your child, it's crucial to assess your own financial situation and ensure you have the means to step in and make payments if needed. Lenders will typically require co-signers to have a stable income, a low debt-to-income ratio, and a good credit score. Additionally, consider whether you can truly afford to pay the loan on top of your own mortgage, debts, and everyday living expenses.

Impact on Creditworthiness

Co-signing a mortgage can have both positive and negative effects on your creditworthiness. If your child makes timely payments, it can improve your credit score as it reflects well on your debt management abilities. However, if they miss payments or default on the loan, your credit score will suffer. Late payments, foreclosures, or other adverse actions by the lender will appear on your credit report, impacting your ability to borrow in the future.

Long-term Commitment

Co-signing a mortgage is a long-term commitment that can be challenging to get out of. You will likely be tied to this agreement until the loan is repaid, refinanced, or the property is sold, which could be many years down the line. During this time, you will need to monitor the loan activity closely to ensure payments are made on time and to protect your credit.

Family Relationship Considerations

Financial matters can complicate family relationships, and co-signing a mortgage is no exception. If your child fails to make timely payments, it can lead to difficult conversations and strain your relationship. It's important to set clear expectations and have honest discussions about financial responsibilities to mitigate this risk.

Alternatives to Co-signing

If you're hesitant about co-signing a mortgage, there are alternative ways to help your child purchase a home. You can provide financial assistance with the down payment or closing costs, lend them the money directly, or even consider becoming their landlord by purchasing the home yourself and renting it out to them until they can secure their own mortgage.

In conclusion, co-signing a mortgage for your child can be a helpful step towards homeownership, but it's important to carefully weigh the pros and cons before making this significant financial decision. Ensure you have a comprehensive understanding of the risks involved and that you are financially prepared to take on this commitment.

Providing the mortgage yourself

In Canada, you can use a self-directed Registered Retirement Savings Plan (RRSP) to finance your own mortgage. This strategy involves placing the mortgage into the RRSP, which can be considered the fixed-income portion of your portfolio holdings. Instead of paying principal and interest to the bank, you pay them to your RRSP.

• Start with a mortgage-free home or have at least 50% equity in your home.
• Establish a non-registered investment portfolio.
• Set up an RRSP mortgage on your home. The mortgage rate is typically the current posted rate, and the lender will use your home as collateral.
• Make monthly payments to your RRSP instead of the bank. This is a tax-free transfer of equity from your home into your RRSP.

There are some costs to be aware of when setting up this type of mortgage:

• Initial set-up fee from the lender: Approximately $300
• Start-up legal fees: Approximately $500+
• Annual administration fees charged by the lender: Approximately $200/year
• CMHC fees of around 0.5% of the mortgage principal
• Annual self-directed RRSP administration fees: Approximately $150 per year

It is important to remember that the main goal of your RRSP is to maximize the rate of return so that your money can compound and grow for retirement. With today's low rates, it can be challenging to use a self-directed RRSP to create a deductible mortgage and grow your retirement savings.

Additionally, mortgage payments made to your RRSP do not generate tax savings. Therefore, this strategy may be ideal if you are not solely relying on an RRSP for retirement or if you are a conservative investor who is not concerned with maximizing annual tax rebates.

Buying a home as a gift

Gifting a home to a child or loved one can be a wonderful gesture, but it's important to be aware of the rules and regulations around this process. Here are some key things to keep in mind:

Understanding Down Payment Gifts

Down payment gifts are a common way to help someone buy a home. The money is usually gifted by a close friend or family member to cover the upfront cost of purchasing a home, known as the down payment. This can range from 3.5% to 20% of the home's price. While monthly mortgage payments may be affordable, the initial down payment can be a significant hurdle for many, especially first-time homebuyers.

Lender and Loan Requirements

Before using a down payment gift, it's crucial to check with the lender and understand the specific loan program's requirements. Some loans may have strict guidelines on how much gift money can be used and who can provide the gift. For example, conventional loans typically require the gift to come from a family member or domestic partner. On the other hand, FHA, USDA, and VA loans allow gifts from close friends, charitable organizations, government assistance programs, or even the borrower's employer. It's important to note that the gift usually cannot come from anyone involved in the transaction, such as a real estate agent or seller.

Gift Letter and Paper Trail

To ensure a smooth process, a gift letter is often required by the lender. This letter confirms the relationship between the giver and recipient, states the amount of the gift, and includes a declaration that the money is a gift with no expectation of repayment. Additionally, a paper trail showing the transfer of funds from the giver's account to the recipient's is essential. This may include bank statements, withdrawal and deposit slips, or online statements.

Tax Implications

While the recipient of the gift typically does not have to pay taxes on the money received, the giver may have tax obligations. In 2024, an individual can gift up to $18,000 (or up to $36,000 if married) without tax consequences. However, amounts above this threshold may be subject to gift tax, and it's important to consult a tax professional for specific advice.

Advantages of Gift Money

Using gift money for a down payment has several benefits. It enables the recipient to purchase a more expensive home or reduce the total amount financed. Additionally, it can speed up the process of saving for a down payment, bringing the dream of homeownership closer to reality.

In conclusion, buying a home as a gift can be a generous and life-changing gesture. By understanding the requirements, documentation, and tax implications involved, you can ensure a smooth process and help your loved one achieve the milestone of homeownership.

Buying a multi-unit property

A multi-family home is any residential property where multiple families can live, such as a duplex or a condo. These properties typically have at least two separate housing units and share common areas like hallways, stairwells, and outdoor spaces.

Pros and Cons of Buying a Multi-Family Home

Pros

• More potential cash flow
• Can expand your portfolio quickly
• Diversified and reduced risk due to multiple units and a larger pool of tenants
• Tax benefits: you can write off mortgage interest and repair, maintenance, and advertising costs as business expenses

Cons

• Upfront costs can be pricey
• Competition for multi-family homes may be fierce
• Possibility of vacancies and late rental payments
• May be more difficult to sell as not everyone is interested in or can afford a multi-family home
• Higher ongoing costs and property management needs

Steps to Buying a Multi-Unit Property

Determine Your Budget

Consider closing costs, carrying costs, renovation costs, and ongoing repair costs. It's also a good idea to overestimate your expenses and have a larger cash reserve than you need.

Examine the Different Types of Multi-Family Properties

Research the three main types of multi-family properties: residential multifamilies (duplexes, triplexes, and fourplexes), apartment complexes, and turnkey properties.

Research Potential Neighborhoods and Choose a Location

Location significantly impacts the financial success of your investment. Consider the local rental market and the property's proximity to schools, hospitals, stores, and other establishments.

Choose a Lender and Get Pre-Approval

Find a lender who understands real estate investing and get pre-approved before visiting potential properties. Loan options include conventional, FHA, VA, and commercial loans.

Shop for a Home

Use online tools like MLS or work with a real estate agent to find suitable properties within your budget and criteria.

Fill Out a Mortgage Application

Provide the lender with documents to verify your income, employment status, credit history, and savings.

Make an Offer and Close the Deal

Work with a real estate agent to negotiate and make an offer on the property. Once the seller accepts, move into the closing process, which includes getting an appraisal and inspection and paying closing costs.

Decide on Property Management

You can manage the property yourself or hire a property management company. Either way, set aside funds for routine maintenance and unexpected repairs.

Tips for Getting Ready for a Multi-Family Home Loan

• Explore financing options: multi-family properties are eligible for conventional, government-backed, and commercial loans.
• Save for your down payment: the amount will depend on the loan type, but conventional loans typically require a 25% down payment, while FHA loans may require as little as 3.5%.
• Work on your credit: pay off debt, pay bills on time, and correct any errors on your credit report to improve your loan approval odds.
• Explore local resources: research housing assistance, first-time homebuyer programs, down payment assistance, and grants in your area.

Common Loan Requirements for Multi-Family Homes

• Conventional loans: typically require a minimum credit score of 620 and a 25% down payment.
• FHA loans: require a minimum credit score of 580 with 3.5% down or 500 with 10% down, and you must live in one of the units.
• VA loans: no minimum credit score, but lenders generally prefer a score of at least 620. These loans are for eligible veterans, active-duty service members, reservists, and surviving spouses.

Frequently asked questions