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Saving for a down payment is becoming increasingly tricky in this market. Housing prices are rising faster than buyers can keep up with, and homeownership seems like a faraway goal. For some people, the option of a gifted down payment is appealing, and it might be the key to becoming a home owner more quickly. While gifted down payments have their advantages, they also come with some risks that are important to know before you accept the gift. Here are the big pros and cons of this type of financing, and some extra aspects you’ll need to consider.
Pros of gifted down payments
Buy a home faster
The most obvious benefit of a gifted down payment is, as a buyer, you now have a big influx of money to use to buy a home. Many Canadians spend years saving for their down payment, so a gifted down payment allows you to enter the market more quickly while you focus on saving for expenses like utilities and mortgage payments.
Expand your budget
Depending on the size of this gift, your budget could be bigger than you originally thought. For example, maybe you were saving on your own for a $500,000 home, but your gifted down payment is big enough to cover 20 per cent of a $700,000 home. This means you can increase your budget, and therefore, your housing selection. In addition, you won’t need mortgage insurance since you now have a 20 per cent down payment instead of 10 per cent, which allows for a smaller mortgage.
Money is non-taxable
Receiving a gifted down payment isn’t taxable. If your family provides you with a down payment, for example, this means you won’t need to pay taxes on that amount as it’s not considered taxable income. Since there are no tax issues, you don’t have to worry about using that money for anything other than its purpose.
Cons of gifted down payments
Risk of becoming house poor
A down payment isn’t your only expense when buying a home. If you purchase a home beyond your means, you will likely end up being house poor. This means the majority of your income will be spent paying for housing costs like your mortgage payment, insurance and utilities. Remember, the process of paying for a home isn’t over once you sign the papers. You must buy a home you can afford down the line.
Risks for gifters
The person giving the down payment has to be able to afford it as well. Often, parents refinance their own mortgage to help pay for their kids’ down payments, which can be risky if the market were to correct and their home value went down. Parents may also need to consider their own financial plans for the future and retirement, and be able to pay the money back if they borrow it.
Discussions of repayment
While gifted down payments often have good intentions, they can result in some tense family issues if not discussed beforehand. It’s important to be clear it’s a gift, not a loan, and the person receiving it doesn’t need to pay it back. Lenders will be more hesitant to provide a mortgage to someone who has another loan they need to pay back to their family. If the person who gifts you a down payment expects repayment, this is more likely to cause troubles with lenders when looking for a mortgage.
Things to remember
Your lender will require a signed letter from the person who is gifting you the down payment. This letter states the donor understands the down payment is a gift, not a loan, and they will not receive repayment. This is an important step in the process of accepting and using a gifted down payment.
Proof of source of funds
Apart from the letter, lenders may need other verification that the source of funds is legitimate and not illegal. For example, lenders may want to contact the donor to confirm they are who they say they are. Since down payments are a significant amount of money, lenders take these extra steps to prevent money laundering.
Buyers still have to make payments
Lenders don’t allow buyers to rely completely on someone else to buy a home. Buyers need to prove their ability to cover closing costs and future costs for the home before they are approved for a mortgage. Lenders need proof you are a trustworthy buyer with your own independent source of income.
Gifted down payments can be a great way to help buyers purchase a home, especially in a market where housing prices are constantly rising. However, it’s still important to know all the rules surrounding this form of financing, and to have an open discussion with your donor(s) about the process. It’s also handy to use a mortgage broker to help you understand how a gifted down payment works.
Have any questions about gifted down payments or other mortgage information? Get in touch with us at Clinton Wilkins Mortgage Team! You can call us at (902) 482-2770 or contact us here.