Sometimes, the fact that you can do something doesn’t mean that you should do it.
Being a parent is an extraordinary, daunting, rewarding, overwhelming, wonderful, life-changing, inspiring and often unpredictable experience. It’s also a role that requires you to relearn everything you know over and over again. Whenever your child arrives at a new life stage, you face a new set of questions and possibilities.
When it comes to financial planning, one ongoing challenge for parents is making decisions about when, why and how much money they give their children.
Many of my clients are in a situation that you may be familiar with. They are grappling with whether or not the Bank of Mom and Dad should help children get into the real estate market in Toronto. After all, they want what’s best for their kids. What could be better than helping them buy their first home?
As a Chartered Financial Planner, one of my primary responsibilities is to help clients understand the long-term implications of their decisions.
I am also guided by a personal and professional mission that runs much deeper. I want to help people achieve financial independence so they can become their best self and live their best life.
Guided by this mission, I’d like to invite you to think differently about your child’s potential house purchase – and your role in it.
The question isn’t “can I afford to help?” The question is “can my child afford to accept my help?”
Asking this question leads to me giving clients advice that isn’t always popular with their children. (Though I guarantee that when they look back 30 years from now, they will be glad their parents asked it.)
Here’s the advice: if your child needs help buying a home, they can’t afford to buy a home.
I have written in the past about parents having strict rules for when a child borrows from the Bank of Mom and Dad. In this blog, I’d like to dive into the details of a potential house purchase to illustrate how it can become a bad situation for all involved.
Do your homework
An important guideline for any financial decision is to do your homework and understand all of the implications of the decision – now and in the future.
To explore the topic of helping a child with a down payment, let’s look at some numbers. After all, what would one of my blogs be without some numbers!
First, let’s assume that you – the parents – are in your 50s and have a 28-year-old first child who is either married or in a serious long-term relationship. Your child and their partner have decided they want to buy a home in Toronto. They have saved $50k for a down payment. Their current combined annual gross income is $140k per year.
Now, let’s assume you talk through some options for how you might contribute and reach the following agreement: you will help the young couple with a down payment and they will cover all carrying costs of the house.
Sounds good, right? Not so much.
Always start with the numbers
If we assume a five-year mortgage rate of 3%, the couple’s maximum affordability will be $857,097 (Note: the average selling price in December2 2019 for a residential property in Toronto was $837,778.)
Most parents’ instinct is to help their children by getting them up to the 20% down payment threshold, so they can avoid paying CMHC’s mortgage insurance premium.
According to the Ratehub mortgage calculator1, a 20% down payment would be $171,479. If the couple buys a home at exactly their maximum affordability, they will pay $18,755 in land transfer fees and $1,850 in legal and closing costs.
Given that scenario, here are the likely financial commitments for the new homeowners:
- Cash down payment: $192,084
- Mortgage payment per month: $3,245
- $1,000 per month for property taxes, utilities, property insurance, phone and internet
- $1,000 per month for transportation, groceries and dining out
- $500 per month for home maintenance and furnishings
- $13,500 each (or $2,250 per month combined) for RRSP contributions
- $100 per month each for employer health insurance
With those numbers in mind, let’s look at their cash flow, which is one of the most important considerations for assessing the financial impact of a decision.
If we assume each of the partners earns $70k, their net combined take home pay will be $105k, and they will bring in $8,750 per month. The expenses above come to $8,195 per month.
This leaves the couple with only $555 in net positive cash flow per month.
Based on these numbers, here are five reasons to avoid the above purchase.
1. You can afford to help them buy a house, but they can’t afford to own a house
Look at the numbers. The couples’ take-home pay is almost equal to the costs associated with carrying the property and living in Toronto. If that’s their situation, they will have next to no capacity to cope with unexpected expenses. What if they face a major home or car repair? Or a prolonged illness? What happens if one of them loses their job or experiences a drop in income for some reason, such as a decision to start their own business?
In this scenario – which is fairly common – your decision to help with a down payment is also a decision to be the contingency fund for any unexpected expenses – even if you and your child don’t want that to be the case.
Think of it this way. If the young couple hits a rough patch of unexpected costs or reduced income, what are you going to do? Sit back and watch as they struggle to cover basic expenses? Tell them they are on their own when they can’t pay their utilities? Let their debt burden grow and grow?
That’s not how families work. In for a penny, in for a pound.
If your child and their partner start out with such a tight budget, you will eventually be drawn into helping them cover their expenses, which isn’t what any of you have in mind.
2. Financial problems often lead to relationship challenges
There is no stress quite like money stress. It permeates everything we do, every decision we make and our ongoing experience of life. It’s the opposite of how financial independence can help you become your best self. Financial difficulties can bring out the worst.
This is particularly true for relationships. Looking back at my marriage, most of our arguments were either about the kids or money issues.
When money is tight, there is either looming dread about mounting debt or ongoing stress about a budget that makes any small expenditure contentious. It’s also challenging when both partners have to delay most personal expenditures, because it can lead to resentment and regret.
In my marriage, when we had a cash crunch, we fell into a cycle of pointing fingers and speaking unnecessarily harsh words we both ended up wishing we could take back.
Professionally, I have also seen many marriages come to an early end because differences in the partners’ attitudes toward saving and spending drove a wedge into the relationship.
Helping your child and their partner with a down payment seems like a wonderful boost to their relationship. But setting them up to own a home they can’t afford has the potential to introduce stresses into their lives that could lead to consequences you didn’t intend.
3. Save for tomorrow, live for today
No matter how certain a young couple wants to be about how their lives will unfold, they can’t really know. Maybe one of them will want to change careers. Maybe they will explore an interesting opportunity together. Maybe they will pursue a lifestyle option that doesn’t generate a lot of cash flow. Who knows?
What’s more, as much as I am a strong advocate of deliberately and carefully saving for the future, I also know – especially lately – how fleeting life is. A young couple only gets one chance to begin their life together. I hate to see those magic years take place under a cloud of financial worry.
I can tell you from personal experience that taking on too much house too soon is a problem. When my wife and I were first married, we bought a far-too-expensive-for-us home that made us house rich and cash poor. We spent so much of our income on home ownership (including mortgage payments, property taxes, maintenance and utilities) that we had very little room for any other spending. We rarely had the funds to take a vacation, dine out or finish furnishing our home. And we lived with constant stress.
Looking back now, I wish we had been more conservative with our first home purchase so that those early years could have been more enjoyable.
I’m not advocating for young people to spend all of their income. In fact, my perspective is based on the assumption that they will start saving for financial independence right away. But adding the overwhelming costs of owning a home before they are ready is an undue burden on a young couple.
4. Helping with a down payment may limit your retirement plans
In our example above, the young couple needs you to provide $121,479 for their down payment.
If this were my personal situation, I’d want to offer this amount to all three of my children. That would mean I am on the hook for combined down payments of at least $365k (after tax).
As a dad who is also a Chartered Financial Planner, I’d advise you to think through the financial implications of a gift of that size, because it may have a negative impact on your own plans for retirement.
If I look at my own life, there is a lot I don’t know about how it will unfold.
I don’t know how long I will live. I don’t know how my investments will perform. I don’t know the exact inflation rate. I don’t know how my health will hold up. And though I am pretty sure I want to keep working, I don’t know exactly for how long and how much.
Without a level of certainty, it’s difficult to make accurate retirement projections, which means it is difficult to accurately assess the impact of the down payment on your long-term financial security.
You want to help your children. But neither you nor your child want you to jeopardize your own retirement options.
5. Grandchildren?
Personally, I haven’t given much thought to having grandchildren, but I have seen the joy and happiness my children brought to my parents and in-laws.
When a young couple is burdened by financial obligations, they may put off having a family. That’s fine if a delay – or not having children at all – is in line with their personal goals.
But what if they want to have kids sooner rather than later? What if they want to be young parents and give you an opportunity to be young grandparents? It would be a shame for them to have to delay something so wonderful just because they own a home they can’t afford.
Those are five reasons to consider whether helping with a down payment will really be a help.
As I have said, my advice on this subject is this: if your child and their partner need your help buying a house, they aren’t ready to own one.
Whether you do financial projections yourself or ask a professional planner like me to run the numbers for you, make sure you do the homework. You want to fully understand the implications of your decisions. And you definitely want to avoid getting swept up in the trend of parents rushing out to buy a preconstruction condo for their kids.
Did this article resonate with you? What did I miss? Send me a note and let’s start the conversation.
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Call me if you want to map out how you can Never Retire. You can also subscribe to our Never Retire newsletter, contact us to Order a complimentary book, register for one of our events, and call us to meet with a Certified Financial Planner. We offer you a range of services from a wealth plan to investment advice or help you take advantage of our investment models. Call me at 416-355-6370 or email me at richard.dri@scotiawealth.com.
1https://www.ratehub.ca/mortgage-affordability-calculator
2http://www.trebhome.com/files/market-stats/home-price-index/TREB_MLS_HPI_Public_Tables_0120.pdf
source https://richarddri.ca/to-help-or-not-to-help-your-child-buy-a-home-that-is-the-question/
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