Given the state of our real estate market, the insane prices of houses, and the ever increasing costs of living, young people are nearly finding it nearly impossible to acquire their first homes. We are amid record home prices in parts of the country and more parents are finding their children in need of down payment assistance.
This may all be fine and dandy, but we also live in an ever increasing world of marital breakups and divorce. That makes it a very difficult decision for parents who want to help their children. All is great so long as the happy couple goes on to live a long and happy life together.
But what if the relationship goes sour? What becomes of a parent’s generous financial contribution? Let’s explore that below. First, however, let’s look at why this is a growing problem.
Divorce rates rising post-pandemic
Canada’s divorce rate is widely accepted to be around 40%. Some now expect that figure to jump as pandemic restrictions ease and more services, including divorce court, are back in full operation.
Some law firms are seeing 20% increases in inquiries about divorce procedures compared to pre-pandemic. Part of the reason for the expected increase is the increased time spent together at home. Spouses are under increased stress due to the pandemic, often juggling household and work demands while spending more time looking after their children. For those already on shaky grounds, that can put you over the top.
More parents are contributing
Of those who bought between 2015 and 2019, a full 40% reported receiving financial gifts from parents or other family members for their down payment, according to recent data from Mortgage Professionals Canada. That’s up from 30% for those who purchased from 2010-14, and 24% for those who bought between 2005 and 2009. Another 20% of today’s buyers accepted family loans as part of their down payment, up from 13% for those who bought between 2010 and 2014.
Combine increased marital friction with the growing trend of down payment assistance and you get more risk for parents.
What’s the risk?
The problem with gifting funds to your child and their spouse is that, in the event of separation or divorce, the spouse will usually be entitled to half of the home’s equity once the mortgage is paid.
If the separation occurs soon after the house purchase, the majority of that equity may be your financial gift. While gifts from third parties are often exempt from equal distribution when couples separate or divorce, that’s often not the case.
In Ontario, for example, the value of the matrimonial home, and any gift toward the home during the marriage, must be divided equally between the spouses upon separation. Laws are similar in some of the other provinces.
How can parents protect financial gifts
Parents wishing to make homeownership a reality for their children need to have some documentation that clearly states that the gift is for one person only, as how a home is used will determine the status of the gift if there is no contract on this issue.
So how do parents go about doing so? Here are some points of consideration:
Option 1: To help ensure that the down-payment gift remains with the intended person upon separation or divorce of a marriage, a prenuptial agreement is best. That, of course, can be an awkward conversation to have with partners, creating unwanted tension.
Option 2: Another option is for parents to loan their child the money to prevent it from becoming communal property. It can even be made forgivable. If the marriage breaks down, the lender can be asked to be repaid. Since it’s a loan and not an asset, it is generally not considered divisible as part of the family property. But since the money would be expected to be repaid, it creates two mortgage problems:
- It increases the borrower’s debt ratios, a calculation the lender uses to determine if you can make your mortgage payments. This may be true even if there are no actual payments during the mortgage term, as some lenders will factor in theoretical payments, and
- It’s considered an unsecured borrowed down payment, which some lenders and default insurers, like CMHC, do not allow.
Option 3: A third option is for the parents to retain title of the property that their child is purchasing, although there may still be exceptions. For example, if the parent intends for the couple to have full ownership and lets them invest their own time and money to maintain the house, there are instances when the separating partners might be able to prove a claim in equity against the house and recoup some of the value of his or her labour.
Option 4: A fourth option is to register the loan as a second mortgage with a balloon payment if the house is discharged. Again, that won’t be allowed by some lenders and insurers. Hence, your mortgage options shrink and you’re unlikely to get the lowest rate in the market.
Option 5: Yet another option is for the property to be owned by a trust, since assets held in a trust would not belong to the spouse. There are exceptions here too, particularly if the spouse is a beneficiary to the trust. That’s not to mention the difficulty of finding a mortgage lender willing to entertain this structure.
As with any real estate transaction, especially involving large sums, a chat with a financial life planner, lawyer, and accountant is definitely a good idea if parents are considering gifting their children, and their partners, for their down payment on a house. Northern River Financial has increasingly had this conversation with clients, and prospects, and maintains strong relationships with the appropriate professionals to consult and refer.
In the end, a prenuptial agreement may be the most uncomfortable solution for protecting your gift to a child, but it’s also generally the most effective. Although, it may be less contentious if the parent proposes it on the advice of their lawyer, rather than the child bringing it up to their partner. This is becoming more of a reality and it is a prudent way to Keeping Life Current.