'Tis the season for giving. And for many parents across the country, that means gifting down payment funds to help their child get a foothold in the housing market.
And apparently there are a lot of generous parents out there. Recent statistics suggest upwards of half of recent millennial homebuyers had at least some down payment help from their folks.
For those who want to contribute to their children’s dream of homeownership, here are some points to remember:
Most lenders require that gifted funds used for your down payment come from an immediate family member (parent, grandparent, child, sibling or legal guardian). That means your Great Uncle Fester twice removed, unfortunately, can’t contribute to your down payment fund, depending on your choice of lender.
Quick Tip: Some lenders don’t have this restriction. Some even let your employer gift you a down payment, if you have 20% down. But the general rule above stands, and if you want a lender who makes exceptions to it, you’ll rarely get the lowest mortgage rates.
Secondly, the money being gifted needs to be just that—a gift. It may sound self-evident, but it’s an important distinction.
Should there be any expectation by your family members that the money needs to be repaid, your gift then becomes a loan. Borrowing a down payment has three implications:
- Some lenders don’t allow it
- Those that do include an imputed loan payment in your “debt-service ratios,” which are used to qualify you for your mortgage
- A borrowed down payment increases your default insurance premium by 0.50 percentage points if you are putting down less than 20%.
Gifted down payments are also prohibited by some lenders if:
- The property is non-owner-occupied (e.g., an investment/rental property)
- Your income cannot be proven in a traditional manner (as is sometimes the case with self-employed borrowers)
- You’ve previously had a bankruptcy
- You’re getting a readvanceable mortgage (i.e., a HELOC or mortgage linked to a secured line of credit)
- The gifted funds are from out of Canada.
An eager homebuyer might think they can simply cash a cheque from mom and dad and use the funds to put towards their down payment.
The process actually requires a little more record-keeping in order to satisfy the lender that all funds are legitimate and truly a gift (as opposed to a loan).
This requires a mortgage gift letter to be signed by the parties. This letter typically includes the following details:
- Borrower’s name
- Date (not to be more than 30-90 days old, depending on lender policy)
- Donor's name, address, and phone number
- Donor's relationship to the borrower
- Amount being gifted
- A statement confirming the gifted funds are unencumbered and not to be paid back
- Address of the property being purchased
The lender also requires a copy of the cheque showing the gifted funds, and proof that the funds were deposited in your bank account. Make sure you deposit the gifted funds well in advance of closing (at least 30 days, especially if they’re coming from another country).
Some lenders will also ask to see proof of the source of gift funds (e.g., a bank statement from your grandfather showing the exact dollar amount coming out of his bank account).
Benefits of a Gift to Top Up Your Down Payment
Aside from making homeownership possible in the first place for many, a financial gift from a family member can go a long way towards saving you thousands of dollars over the life of your mortgage.
Consider a $500,000 purchase where you only have 5% down, for example. An additional $100,000 down payment:
1) Lowers your interest expense by almost $14,000.
2) Slashes your monthly payment by $472 a month.
3) Cuts your default-insurance bill by $19,000, plus all the interest you’d pay to finance that default insurance (since it’s normally rolled into your mortgage).
Explainer: By law in Canada, you must buy default insurance when buying a home with less than 20% down (unless you use a very expensive non-prime lender). If a gift puts you over the 20% down payment threshold (as in this example), you’ll save thousands by avoiding default insurance. These “high-ratio default insurance premiums” range from 2.80% to 4.00% of the mortgage amount.
4) Eliminates the tax on default insurance (Manitoba, Ontario, Quebec and Saskatchewan all charge provincial sales tax on the insurance premium, which can be hundreds or even thousands of dollars).
In short, parental donations can be a life-altering financial event. They help young people start amassing home equity quicker, mitigate the risk of price inflation while they rent, and retire with a lot more money in their pockets.