6 things to consider before borrowing from the Bank of Mom and Dad for your first home
Borrowing from family can seem convenient, but there are things to think about first, like interest, taxes, family power dynamics and more.
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As homes remain unaffordable to many Canadians, more and more young adults are turning to the Bank of Mom and Dad to help with a down payment or with mortgage payments. A recent CIBC survey showed that 31% of first-time home buyers in Canada received financial help from their parents or a relative, with the average gift being $115,000. While mom and dad’s money can certainly boost your down payment, borrowing from family does come with some financial and relationship considerations.
Before locking into a familial loan, both parties must assess whether they are on the same page and are in a position to take on this type of agreement—along with knowing the power and relationship dynamics that could come with it. Here are six key considerations when borrowing from the Bank of Mom and Dad for your first home.
1. Is it a gift or is it a loan?
Determine if the financial help you’re discussing with your family is a gift or a loan. “Make sure there’s good communication with regard to the parent and the child about the nature of this,” explains Nicholas Hui, P.Eng, CFP, an advice-only Financial Planner at VAVE Financial Planning. “Is it a gift, or is it a loan? If it’s a gift, then I highly recommend having a ‘gift deed.’ A loan could be set up with some type of contract with payment terms and then seek legal advice to make it rock solid.” (More on gift deeds in a sec.)
If it’s a gift
If your parents gifted you money toward the down payment for your home purchase, then your mortgage lender may need proof of a gift deed or gift letter. In Canada, a gift deed is a legal document that transfers ownership of a property or asset from one party to another without exchanging money. This document confirms that the down payment amount from your parents is truly a gift and not a loan, which helps your lender verify the source—and nature—of the funds.
Hui also suggests discussing with your family whether it’s part of an early inheritance and, if not, whether other siblings should be informed to prevent future miscommunication over the division of assets, especially after your parents pass away.
If it’s a loan
If you’re considering a loan from a family member, discuss interest. If your parents decide to charge interest, it’s not necessarily a bad thing. For one, it could be beneficial to keep those funds “in the family” and support the Bank of Mom and Dad instead of a financial institution or mortgage company. And you’ll likely benefit, too, if the agreed-upon interest rate is less than prime.
Hui says parents could consider using the prime rate of Canada as a guideline (currently 6.95%) and then go a little lower or higher than that—but he says it’ll depend on the dynamics, loan amount and other factors.
Whether interest will be charged or not, Hui suggests having all aspects of the agreement—repayment timeline and terms of the loan—put in writing so everyone is on the same page.
2. Consider the tax implications
While there’s currently no “gift tax” in Canada, there are some tax implications to be mindful of. Interest charged on a loan is taxable income, so your parents will need to know that. “Like any investment, they’re loaning money to their child. If you pay them ‘income’ for that loan, it’s taxable,” Hui says.
And on the borrower’s end, just like interest paid on your primary residence—unless it’s used for business purposes or a rental property that generates income—the interest paid on the loan is not tax deductible.
3. Consult a financial planner
Hui advises the entire family—not just the home buyer—meet with their respective financial planners before signing the dotted line. Despite the goodness of mom’s and dad’s hearts, it’s always a good idea to assess whether parents can truly afford to give this gift or loan.
“Many parents either borrow from their home with a home equity line of credit (HELOC) or take out a reverse mortgage to help their children. But we want to make sure that the parents can afford it. We don’t want them to jeopardize their own retirement or anything like that.”
From the borrower’s side, he says there should be some financial—and multi-scenario—planning. He’s seen situations where parents provide a down payment, but their child can’t afford the mortgage payments. Essentially, money from parents can artificially inflate a child’s affordability and ability to pass the mortgage stress test. But, In some cases, if the bank denies a mortgage due to insufficient income, Hui suggests it might not be financially responsible for parents to bridge that gap.
Hui explains that the last thing you want to do is jump through hoops to buy your first home only for it to trap you financially. Planning ahead with cash flow analysis is crucial to ensure mortgage affordability and maintain a lifestyle, accommodate life changes, career moves, travel and/or family plans.
4. Can a parental loan score you a better starter home?
Borrowing from parents may make it easier for you to qualify for a mortgage but remember that banks and lenders may consider any existing loans from family members during the mortgage approval process.
While it’s not necessarily illegal to withhold the info that you borrowed from a family member to help with your down payment, it could have some significant consequences.
When applying for a mortgage, lenders typically require a clear understanding of your financial situation, including the source of your down payment. Most mortgage lenders require a portion of the down payment to come from the borrower’s own resources, and they will also want to ensure that any gifted funds are not loans that could impact your ability to repay the mortgage.
So, while you may qualify for a mortgage more easily or be able to secure a better first property with your parents’ help, the real questions are whether it’s sustainable long-term and how mortgage-strapped you want to be.
5. The pros and cons of borrowing from family
Now that we’ve explored the key considerations, here are the pros and cons of borrowing from family for a mortgage down payment on your first home.
Pros:
Qualifying and passing the stress test with a mortgage lender become easier.
You may pay a lower interest rate compared to financial institutions.
Keeping financial lending within the family can benefit mom and dad in the long run. You might be helping your parents in terms of, say, retirement income, Hui says.
Cons:
Power and relationship dynamics could change when borrowing from your parents, including managing expectations, family dynamics and potentially even household decisions. Hui stresses open and clear communication with everyone involved. For instance, siblings might wonder about fairness or have future expectations of a loan for themselves. Or, a parent power struggle could ensue, like, “I gave you this amount of money so I get a say in what the deck looks like.”
There’s a risk of becoming financially overextended and not being able to sustain long-term home affordability, especially in light of unexpected life events such as interest rate hikes or job loss, which could necessitate selling or downsizing the home. The down payment is only part of the financial picture.
Placing parents in a vulnerable position concerning their own retirement or future financial stability.
Carefully considering all possibilities before proceeding and potentially outlining agreements in writing may help to prevent misunderstandings or family feuds down the line.
6. Your other options: Alternatives to the Bank of Mom and Dad
For Canadian first-time home buyers without financial support from their parents, you do have options. Alternative strategies to enter the housing market include saving for a down payment through a first-home savings account (FHSA), exploring government programs and initiatives, such as the GST/HST New Housing Rebates and the Home Buyer’s Plan (HBP). The latter has a positive new change for first-time home buyers. You can now withdraw up to $60,000 (up from $35,000) from your registered retirement savings plan (RRSP) for a down payment, which went into effect on April 16, 2024.
Other strategies to improve your standing with mortgage lenders include increasing your credit score, starting with a smaller property just to get your foot on the real estate ladder (starter home is the first step), researching affordable neighbourhoods to live in, and educating yourself through resources like the CMHC comprehensive guide to home buying.
