Motherly muddle

“My daughter and her husband, both in high paying professional jobs with a baby on the way are being lured with the siren of home ownership in the Vancouver area,” Jessica writes me.

“I know, I know. I have sent them your blog link. But let’s say, as a parent, I would want to help them. What is the best way to do so that will not decimate our balanced portfolio?”

It’s a common question these days. The Bank of Mom is one of the key financial institutions of the land. Huge. It’s estimated four in ten newbie buyers could afford nothing without the parentals. In Toronto almost a third – 27% – of new owners have their folks on title (and co-signing the mortgage). In the US it’s estimated parents dump almost $3 billion a year into their kids’ accounts for downpayments.

In 2015 the average BoMom gift was $52,000. By 2020 that increased to $82,000. Now CIBC estimates it has ballooned to $115,000.

So the question Jess poses is real, meaningful and consequential. How much of your net worth should you carve off and give to an adult child who is needy and house-horny?

“They currently pay $4,000 a month,” she says of her daughter and hubs. “It’s a lot, but they have great jobs in Van and family around for free babysitting. So the current logic seems to be for retired parents to get a HELOC (that hopefully will not screw up our credit rating–does it?) and kids pay the HELOC instead of $4,000 to a landlord monthly. How best to contribute to their down payment fund? Is the new 30 yr (gulp) mortgage and CMHC insurance cap worth biting on? With dropping rates, what timing is best?”

Whoa. Let’s get beyond the baby-is-coming hormones and parental guilt and think about this rationally. First, the arrival of child does not mean (a) its parents need to immediately buy an immense boatload of insurance or (b) that adding a giant mortgage and a property into the mix is a good idea. It’s not. All that does is load stress and change on top of a changing and stressful situation. Babies don’t care much about deeds. Seriously. Wait.

It sounds like Jessica’s kid and partner have good incomes but scant savings for a downpayment. It also seems the parents are (correctly) reluctant to cash in precious retirement assets to hand over a whack of cash as a gift. So, the question is about borrowing money from the parental real estate equity through a line of credit, giving that to the young ones, and having them pay the monthly charge on it.

The average local SFH now sells for just under $2,100,000. And it’s not that nice. These days that buys a Vancouver Special. If you know the city, you understand this is nothing fancy. Never was. Never will be.

Let’s say the kids have saved 10% of the required amount to buy, or just over $200,000. They need double that to close a deal on a $2 million property – which is what Jessica figures might come from a HELOC the parents arrange.

Assume it happens. That line of credit, at the current rate of 6.95%, will cost $1,300 a month in interest, without reducing the debt (and interest-only payments are common with HELOCs). That leaves $1.68 million to be financed as a first mortgage. The cost of that with a five-year loan at 4.7% and a 25-year amortization (never go 30) is $9,486. Property tax and insurance come to at least $700 a month.

So the total carrying cost (excluding utilities and the opportunity cost of a $200,000 in downpayment savings) is around $11,500. The outstanding debt (the mortgage and the line of credit) is $1,900,000. The income required to swing this is north of $400,000 – and at that level the couple will have nothing to put aside for retirement or (more importantly) their kid.

Paying off the parent’s HELOC? Fuhgeddaboudit. Never gonna happen.

The risk, of course, is enormous. If Jessica’s daughter does not have a topped-up mat leave, the kids could be in a cash flow crisis soon after buying. If one of them is laid off, it’s a disaster. Another pregnancy could yield a crisis. Without liquid cash reserves, sickness, relocation, separation or divorce – stuff that life delivers – might also create misery. Is a house with a massive debt worth it?

The options Jess has?

The parents could co-sign the mortgage, of course. Lots of unsuspecting, naïve people do that – not understanding they’re responsible personally for 100% of the entire debt, while not owning the real estate. If the kids lose a job, miss a payment or split up, for example, it could be a nightmare. Or Jessica could just rob her nestegg and hand over a few hundred thousand as a gift. If she’s retired, or close to it, that’s money she can never replace. Lifelong consequences ensue.

Or, finally, house lust could go unfulfilled. No mortgage. No debt. An extra $90,000 in annual cash flow for the young family to invest for the future. A lesson in prudence. Another in patience. Priceless.

About the picture: “Here’s another dog picture for your collection,” writes Kathryn. “Mocha secured both tennis balls today and is looking pretty triumphant. As interest rates go down, how about another article on commuting DB pensions for those of us scared of making that choice? As the Alberta government keeps showing me their foolishness, I am getting more ready to take my money and run and not have to worry about them messing with my pension in future years. What do you think?”

To be in touch or send a picture of your beast, email to ‘garth@garth.ca’.

Source: https://www.greaterfool.ca/2024/09/23/motherly-muddle/