Prospective homeowners have a number of things to get in order before making the purchase of their first home; finding a trusted and experienced real estate professional to work with, getting pre-approved for a mortgage, and saving a down payment, just to name a few.
Today, let’s talk about down payments.
A down payment defined: The initial payment made by the homebuyer when purchasing a house or property. It is a percentage of the total purchase price. The amount required as a down payment can vary.
When purchasing a home in Canada, the requirement set by the government is that you need to have a down payment that falls within the range of 5-20% of the purchase price. For context, in October 2023, the average sale price of a residential property in Kitchener-Waterloo was $767,848.
Saving 5-20% of the average sale price can be a long process for most young adults, so the act of presenting a downpayment as a gift (i.e. from parents to children) has become increasingly popular in recent years.
If you have dreams of leaving your children an inheritance in the traditional sense, you may want to think about a modification to your plan. Instead of leaving a lump sum in the future, consider the impact that money could have on your children’s lives earlier in their adulthood. Consider the idea of a cash gift as their down payment. This approach will not only grant them a solid financial foundation as they embark on their own journey in life and real estate, but it will also grant you the freedom to enjoy your wealth during your golden years.
Thinking about your golden years? Read more: 3 Genius Ways to Generate Retirement Income With Your Home
A gifted down payment defined: When a third-party, typically a family member, provides the funds needed to meet the minimum down payment required to purchase a home.
Why cash gifts are a smart idea for your family
Most of our largest lifetime out-of-pocket costs happen before the age of 40: attending postsecondary school, getting married, buying a home, and starting a family. All of these things cost tens of thousands or even hundreds of thousands of dollars, and that’s money most twentysomethings and thirtysomethings don’t have.
Usually the solution is to take on debt or delay saving for their own retirement, or both, in order to afford these adulthood milestones. But there is better way: help from mom and dad.
Instead of leaving your children a big inheritance, opt for large cash gifts to help them establish financial security early in life. Cash gifts before 40 can have a massive impact for setting your children up on solid financial footing, even if it means leaving them a smaller amount or no money later.
[C]ash gifts in Canada are tax-free, which means it’s better to give your child a $10,000 tax-free gift at 30 rather than leave them $100,000 taxable inheritance 30 or 40 years later. After all, it’s the same money: $10,000 invested in the stock market will grow to $100,000 in 30 years assuming an average rate of return of 8 per cent.
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Advantages of gifting a down payment
By gifting your children money towards their down payment, you can help them expedite their saving timeline and enter the real estate market sooner than expected.
Something else that might be lost in the discussion surrounding gifted down payments is that borrowers could receive better mortgage terms. Sizable down payments typically result in lower loan-to-value ratios, meaning borrowers might be extended lower mortgage insurance premiums or better interest rates. In the end, recipients of gifted down payments will enjoy incredible savings over the life of the mortgage.
Believe it or not, you can experience tax advantages with gifted down payments. They can be allocated to your Registered Retirement Savings Plan (RRSP) for three months to obtain the tax benefits. That said, you must ensure that you maintain enough contribution room in your RRSP to facilitate the gifted sum.
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Another benefit that comes with gifting money to your children earlier in their adulthood is that you get to enjoy it with them. Helping your family financially and enabling them to get into the real estate market is one thing. But being able to spend time with them in their new home, a home where you can all make lasting memories together, is a priceless gift for everyone.
How to gift a down payment
One of the components of gifting a down payment in Canada is a gift letter. It is a document from the gift giver to the home buyer outlining the amount of money being gifted, the property to be purchased, and disclosing that the money is in fact a gift and not a loan. Many banks will have a version of a gift letter for you to use.
In many cases, the bank will also ask for proof of funds.
RE/MAX Canada provided some other things you can consider before making the decision to gift a down payment:
First, it would be wise to disclose these funds to the mortgage lender when applying for a mortgage. Generally, banks will request a gift letter outlining a few things:
- Amount of the gift.
- Relationship between the giver and receiver.
- A statement confirming that the money was a gift and not a loan.
In addition, while a gifted down payment can reduce the strain of the home-buying process, you still need to determine if you can afford to purchase a residential property.
Another thing that some prospective homeowners might need to realize is that the gift giver does not earn a stake in the unit. While this gift was integral to buying a detached house or condominium, it does not mean they are entitled to an ownership stake. To eliminate any possible confusion, be sure to consult with a real estate attorney to have this in writing.
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If you’re looking to help your children get into the real estate market, we’re here to offer our expertise. Contact us today!
