It seems most urgent for parents to help their adult children get into the housing market when real estate prices are soaring.
But now is actually an opportune moment to consider offering money for a down payment. House prices are falling fast in cities across the country, which means parental gifts can help reduce the size of the mortgages first-time buyers must take on. This is huge because the rise in mortgage rates over the past year has made it harder than ever to afford the cost of home ownership.
A parent recently got in touch to ask how best to offer help with a down payment – by tapping the home equity line of credit he and his spouse have on their paid-off home, or by taking out a reverse mortgage.
For some guidance, I consulted Julia Chung, a certified financial planner (CFP) with Spring Planning. She put a lot more emphasis on the planning side of the gift rather than the product used to actually deliver it. But she did ultimately pick one over the other: “I think we might look at the HELOC, just because there’s more flexibility.”
It’s important to note that the interest rates for HELOCs and reverse mortgages have been caught up in the same rise in borrowing costs that has affected mortgages. A HELOC rate might start at 6.7 per cent, while reverse mortgage rates can range between 6.99 and 9.4 per cent right now.
The flexibility Ms. Chung mentioned refers to repayment. A HELOC requires that you at least pay the interest owing every month, but you can repay the principal whenever you want. A reverse mortgage is more comfortable in the near term because you don’t have to repay anything. But when you sell your home, you must repay principal plus interest that has quietly been accumulating in the background.
The reader who asked about HELOCs and reverse mortgages is in his 60s. He and his spouse could be in his home for another 20 to 25 years, long enough to build up interest that cuts significantly into the equity left over from the sale price.
Ms. Chung raised two financial planning issues with a parent gift of home down payment money. One is whether parents can afford to make the gift and still cover their own living costs now and in the future. “How much of your future comfort are you potentially giving away in debt servicing costs in order to manage this?” she asked.
The other planning issue is related to family dynamics. For example, what happens to the gift money if a married adult child gets divorced? The risk is that half the gift money goes to your child’s estranged spouse. To address this risk, Ms. Chung suggested transferring money to adult children via a low- or zero-interest loan or promissory note instead of a gift. Input from a lawyer is strongly recommended.
Finally, Ms. Chung recommends a thorough family discussion, parents and adult kids, about the down payment help. A chance for both parties to air any concerns.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, February 28, 2023