Can I Borrow Money for My Down Payment Using the Bank of Mom and Dad?
Can I borrow money from my parents to use for a down payment on a house and will mainstream lenders accept this? If I do a formal loan with my parents how does that affect my ability to get a mortgage? Will it affect my debt service ratio – the test that mortgage companies and banks use to decide how much money they will lend you. What if you do an informal loan arrangement with your parents? In law, this is likely to be treated as a gift and carries risks of its own. Let’s review why.
What is a Down Payment?
The down payment is the money you invest in your home with the balance being paid by way of a mortgage at the Bank.
According to Ratehub.ca, to buy a Million Dollar home, you need a minimum annual income of $175,000 and a down payment of $200,000. This is the minimum you need. In addition to the mortgage amounts, there are closing costs and land transfer tax of $40,000. So basically you need a quarter of a million dollars just to get into the real estate game.
The next question is whether you can afford the monthly payment, utilities and taxes. There is also maintenance expenses. The minimum annual income to support the debt ratio calculation is $175,000.
Just because you can afford the monthly payment, doesn’t mean this is a good financial decision? You need to consider the impact of interest rate increases, what about life events? What if you want to have a baby and take time of work on maternity or paternity leave? You may not be able to afford this if you are “house poor”.
Turning to the Bank of Mom and Dad
So what are people doing? They are turning to the Bank of Mom and Dad for help. The easiest way for parents to help their children is to give them a portion of the down payment. Parents are giving significant sums of money but don’t realize there is a risk to gifting the money and are shocked to learn that some of the money can be lost.
What are the risks to the Bank of Mom and Dad? Without a formal loan documentation, a repayment schedule and regular payments being made, it is unlikely that the law will treat your money as a loan and it will be treated as a gift. What happens if it is a gift?
Why Not Gift the Money?
A gift is a great option to avoid any issues with the Bank lending money for the mortgage but it creates another problem for you. If you are getting married or are married or are moving in with a significant other, you need an agreement that stipulates the money from your parents is a loan or a gift and it will be returned in the event of a break up or divorce. It’s called a Modern Marriage Contract or a Cohabitation Agreement and it gives everyone involved peace of mind.
What happens if you don’t sign a Modern Marriage Contract?
Let’s walk through the numbers.
Let’s assume you buy a home for $1M.
Closing costs are $50,000.
Down Payment is $200,000. Let’s assume $150,000 is borrowed from the husband’s parents and the $50,000 is paid by the couple.
Mortgage – $800,000
If the couples breaks up and the home is now work $1.2M, the proceeds are divided as follows:
Realtor fees, real estate lawyer fees, disposition costs – $60,000
Mortgage – $800,000
Balance – $340,000 – shared equally – $170,000 to each person.
So the husband invested $25,000 and his parents gave $150,000 meaning his investment was $175,000 but he is only getting $170,000 so he is taking a loss!
The wife invested $25,000 and gets $170,000 or a windfall or almost 7x return.
What an unfair result!
What Happens with a Modern Marriage Contract?
If the couples breaks up and the home is now work $1.2M, the proceeds are divided as follows:
Realtor fees, real estate lawyer fees, disposition costs – $60,000
Mortgage – $800,000
Balance – $340,000 – parents are paid back $150,000.
The balance is $190,000 to be shared equally or $95,000 each.
So the husband invested $25,000 and the wife invested $25,000 and each get $95,000.
It leads to a much better result.
What is the Downside to a Modern Marriage Contract?
There is really no reason not to do a Modern Marriage Contract. The risk of losing equity or your parent’s money is simply too high not to have an agreement in place.
Some people are concerned that asking their significant other for a Modern Marriage Contract is going to make them angry and upset. While that may be the case, protecting the Bank of Mom and Dad at the risk of hurting your partner’s feelings is still worth it. Be respectful and honest in your discussions and your partner will hopefully come around. Read some of our tips here for having this conversation with your significant other.
Another area of concern is that getting involved with lawyers is complicated and will take too long and is too expensive. The Modern Marriage Contract is a package designed to be done online, with the support of a professional team including two independent lawyers and online signing. Most agreements are completed in 4 weeks for a fixed fee. It is simple, affordable and efficient.
Learn more about Modern Marriage Contracts at www.loveandmoney.ca.
To get started, book a free discovery call HERE or email us at admin@mlawgroup.ca
