Some people may find buying a home daunting. The financial requirements for closing on a house can be overwhelming. In addition to a down payment, you need to consider costs for property and land transfer taxes, legal fees, and home insurance. A recent study showed that it takes Canadians an average of 2-5 years to save a down payment. With that much time and money invested it makes sense to be informed. Read along to learn more.
The mortgage approval process
For anyone who has always dreamed of buying a home, the process is similar across Canada. You can work with a single financial institution, shop around different financial institutions, or use a mortgage broker. A mortgage broker will shop around to find different mortgage rate offerings to get you a good deal.
Banks, credit unions, mortgage companies, and other financial institutions will assess your mortgage application to pre-approve you for a home loan. The home approval process requires you to provide information about
Your identity
- Employment status
- Income
- Current assets and debt
- Credit history
- Credit score
- Notice of Assessment (NOA) from the Canada Revenue Agency
You must also prove you can provide a down payment, cover closing costs, and pay your mortgage. This can be done by way of pre-approval. This document shows how much you may get from the bank to purchase a home. An approved mortgage contract will include a mortgage rate. This rate will determine your monthly payments when applied to your mortgage loan.
How much down payment is needed?
The mortgage amount you receive will depend on the property’s value and how much down payment you can provide. After getting a pre-approval amount, a real estate agent can help you find a house within your budget.
You need a down payment of at least 5% of your home value to get CMHC mortgage loan insurance. For homes with a value of $500,000 or less, the minimum down payment is 5%. Home values over $500,000 require 5% down on the first $500,000 and 10% on the rest.
Homes worth $1,000,000 or more do not have mortgage loan insurance and usually require a down payment of at least 20%. The amount of your down payment will determine the insurance premium.
Most financial institutions are required to carry out a mortgage stress test even if you don’t need mortgage loan insurance. The stress test proves you can afford payments if interest rates increase. Financial institutions use the higher interest rate of 5.25% or your negotiated mortgage interest rate plus 2% to calculate the stress test. Use this Mortgage Qualifier Calculator to do a self-assessment stress test.
Gifting a home down payment
Starting in 2023, Canadians can save to buy their first home using the First Home Savings Account (FHSA). The lifetime contribution limit for the FHSA is $40,000. With the average homes ranging from $300,000 to $1,000,000, depending on the location, a 5% to 20% down payment is estimated at a range of $15,000 to $200,000.
With rising housing costs and higher interest rates, many young Canadians are finding out they need help to secure funds for their first home purchase. Sometimes, this may mean receiving cash gifts from family and friends. In addition to saving for their children’s education using the registered education savings plan (RESP), some parents choose to support their children in purchasing a home through a downpayment gift or a loan.
An alternative to gifting family members a down payment to support their home purchase is a co-signed mortgage. A co-signed mortgage has different financial implications. If the child can no longer afford the monthly mortgage, the co-signer becomes contractually responsible for covering the mortgage payments.
If a parent decides to provide a loan instead, the financial institution will consider this as part of the borrower’s debt and assess whether they are able to cover the liability in addition to a mortgage.
What to consider when gifting children a down payment
Financial situation
A mortgage can be a good debt for Canadians looking to get into the real estate market. Parents or guardians who want to help their children with this opportunity should assess their financial situation when gifting a child money for a house down payment. It’s essential to ensure that retirement plans and other financial needs can be met when parting with such a significant amount of funds. A parent gifting a child a down payment should confirm that all sources of income in retirement, such as a registered retirement savings plan (RRSP), Canada Pension Plan (CPP), Quebec Pension Plan (QPP), or tax-free savings account (TFSA), are sufficient to sustain their lifestyle.
Documentation
Generally, financial institutions request documentation showing that a parent is giving a child a down payment for a home purchase. An example of documentation to have readily is a gift letter. The gift letter indicates that the money transfer between parent and child is not a loan that will be repaid later. A good gift letter will include the name of the parents gifting the funds, the name of the child receiving the money, proof of relationship, the amount of the gift, and the date. Sometimes, you may need to provide a signed and notarized letter.
Tax implications
In Canada, there are no tax implications for those gifting a down payment or for those receiving this gift. This is mainly because the gifted down payment is income that has already been taxed by the Canada Revenue Agency (CRA). Other forms of gifts may have tax implications. For example, if a parent disposes of assets in a non-registered investment account to give the proceeds to their children, any capital gains will be taxed in the parent’s hands.
Key takeaways
Due to the higher cost of living, saving up for a house down payment is becoming more challenging. Gifting a child a down payment is an excellent way to help them get a head start in life.
Ensure you have the proper documentation to support a gifted down payment and that the funds are available in time to close on the home purchase. It is important to discuss this with a tax expert and financial planner. They will help ensure there are no adverse tax implications or financial setbacks from providing a down payment gift.