The article “Should you use home equity to buy a house for your kids?” was originally published in MoneySense on October 6, 2023.
Some parents want to help their kids move out by borrowing against their home. Here’s how interest rates and estate planning might impact that idea.
“My husband and I are considering purchasing a second home using the equity in our first home. We own the home—no mortgage. Estimated value is $1.2 million to $1.5 million.
We are hoping to support our children in moving out, while long-term planning for our downsizing when the time comes. We want both homes to remain a part of the estate.
Two questions, is this a good idea, in terms of current interest rates and is it a good idea based on estate planning?” Deanna
Should parents help their kids buy a home?
Deanna, you’re not alone with this type of plan, but few Canadian parents look to get a loan for their kids. A 2021 CIBC report found that 30% of first-time home buyers received support from family members to buy their home. The average gift was $82,000. In Toronto and Vancouver, the average gifts were $130,000 and $180,000, respectively. Parents can borrow against their home to help their kids out. Although you might think that’s where parents’ down payment gifts are coming from, the evidence shows otherwise. CIBC estimates only 5.5% of parents used debt to help their kids buy homes of their own.
How to finance a home for your children
In your case, Deanna, you can borrow against your home using a line of credit or mortgage. The benefit of using a line of credit is flexibility and lower payments. Most secured home equity lines of credit (HELOCs) require interest-only payments. Mortgages, on the other hand, have blended payments of interest as well as principal. The benefit of a mortgage is lower interest rates than a line of credit, but with a mortgage your cash flow is impacted by the higher payments.
If you see this as a short-term debt for a few years before you downsize, I can understand your reasoning. If you are not ready to downsize, but your kids are ready to move out, it may be a way to access that home equity without having to rush yourselves or delay your kids. The short-term interest cost may be a small price to pay for all parties.
You will have to go through the same approval criteria as a borrower for any type of credit, so if you are retired, you may have more difficulty qualifying with a lower income or an income derived primarily from investments. Reverse mortgages are always an option if traditional bank financing proves insufficient. Just be careful about compromising your own retirement for your kids. Home prices could also fall in the future, as they have as of late, and you may not net as much from selling your home as you hope you will.
If you have investments, especially in a taxable non-registered account or tax-free savings account (TFSA), there is a strong case for using these before borrowing right now. You would need to be earning a higher after-tax rate of return on your non-registered investments or a higher TFSA return than your debt’s interest rate to come out ahead. This may be difficult for anyone, and conservative investors in particular, when the bank’s prime rate is 7.2%. The rates on HELOCs are typically prime plus 0.5% to 1%. Mortgage rates may be a bit lower.
Should you buy a home for your kids using the equity in your own home?
One thing to be mindful of for parents is that if your kids cannot qualify for a mortgage on their own, that is a good sign they will not be able to afford the home you are helping them to buy. If you are planning to gift the funds and you do not need or want the money paid back to you, that may be a different story. But you still need to be careful about helping your kids buy more home than they can afford.It sounds like your intention, Deanna, is to buy and own this home yourself and have your kids live in it. You can do that, but you will need to decide with your kids who will be paying for what expenses. It’s best to establish this ahead of time. They could cover some of the expenses, and you do not need to charge them rent. If you do, and the rent is equal to the fair market rent, you could treat the property as a rental property for tax purposes. This would allow you to claim deductions against the rental income like mortgage or line of credit interest, property taxes, condo fees, insurance and/or other ongoing costs.
One drawback of having the property in your name instead of your child’s is that you will likely have capital gains tax payable on the property should it appreciates in value. If it was in a child’s name, they could claim it as their principal residence and have the growth be tax-free.
If you do buy and continue to hold it in your name, there may come a time when it is awkward for you to be the owner. For example, Deanna, if your child gets into a relationship and their partner is then living in a home that is owned by their in-laws. So, despite your best intentions, your child or their partner may want to own their own home as opposed to continuing to live under your roof, so to speak, until you die and they inherit the property.
Document your wishes in a will
Your will dictates what happens to your assets upon your death and you can certainly leave your entire estate to your children or specific assets to specific children. You should also consider what happens if you own real estate that your child lives in, and you become incapacitated. You will want to have a power of attorney for property or similar province-specific legal document to appoint a representative and may want to include conditions for a property you own where one of your children lives.In summary, Deanna, there are a number of considerations with your plan to buy a home for your children using debt secured by your home. Try to consider all factors before you even broach the subject with your kids to make sure it is appropriate for your own financial and family situation.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
