It's that time of year again, when parents start looking for homes for their children to live in while attending a college or university in the Edmonton area. TD Canada Trust recently released a report showing that 10% of Canadian parents would consider buying a condo for their adult children, and our experience shows that many parents in the Edmonton area are interested in this type of investment. We've written articles on this in the past, but this time I'd like to focus on some of the financing options parents have available to them.
Many parents will fork over the down payment and have their children pay the monthly costs; this helps their children get into the real estate market and establish credit while securing an investment or retirement property for themselves. The decision many parents face is who to put on title, and how to finance the property; speaking with your accountant and lawyer prior to these decisions is a must. Here are a few pointers to keep in mind:
- If the condo is in your name, as your secondary residence you could end up paying a lot in capital gains tax when the time comes to sell (assuming it increases in value).
- If your kids are making the payments make sure they can actually afford them (plus taxes, condo fees, utilities etc).
- As with all real estate make sure you look at it as a long term investment - don't expect to make a profit after a year or two.
I asked Gord McCallum at First Foundation (an Edmonton & Calgary mortgage broker) to outline some financing options for parents and he suggested three:
- Buy it as a rental property. This requires a minimum of 20% down. The big advantage here is that the interest on the mortgage is fully tax deductible, as would be the interest on the down payment if you borrow it as well. Essentially you would be able to deduct 100% of your interest costs against your income. The downside is the treatment of capital gains tax. Again, your accountant should be consulted to help make this decision.
- Co-sign the loan. Have your kid(s) on title as the principal buyer(s) and you as a co-signor. The property is considered a principal residence and not a revenue property, so the interest is not deductible and you should not face any capital gains tax. The main reason someone might pursue this strategy is if they prefer to be more highly leveraged and put as little as 5% down (which would also mean you have to pay CMHC insurance premiums).
- Purchase it yourself. The CMHC "second home mortgage" program allows you to purchase it yourself with as little as 5% down. Your children don't need to be on title but do have to live in the property. In addition you are not allowed to generate any revenue from the property (i.e. a roommate) as per the terms of the program.
All of this brings up estate issues as well which can get quite complicated, especially if you have more than one child... one more reason to consult both your lawyer and your accountant before signing on the dotted line.
If you're looking for a condo for your kids we've created a list of all the condos for sale near the University of Alberta.
When you can rent cheaper then why would someone like to buy at top of the market. We can see that inventory is flooding and RE price can go only in one direction. Last Quarter 2010 will be interesting.
http://www.theglobeandmail.com/report-on-business/april-home-sales-inch-downward/article1571202/
It’s a great way to get in. If at all possible, I’m a fan of the second option. Having the property in your kids name usually means it’s their principle residence and saves the tax when it comes to liquidation. The second home mortgage is a great second option. A little planning goes a long way.
Ron,
Let’s say you have 3 children who will be going through school for a total of 10 years. Would you rather pay average rent of 1200 per month, for 10 years for a condo, or put 10 years of payments into a mortgage, and come out with some equity at the end. Pretty simple.
Release the bears!
Actually it’s not simple.
The money you save from renting (rent lower then a mortgage?!? You can rent a nice apartment on Sask drive minutes from the U of A for $1000 and coming down) could be invested in something better than real estate which looks to be peaking. Also real estate with a small down payment you are heavily leveraged (small drop in housing you lose a lot of you initial investment). If you like heavily leveraged investments you can try some margin trading, it’s really exciting.
With 5% down you only own 5% of your condo(less in a few months). Interest payments (which are going up) are just paying rent to the bank.
You can build equity while renting, it just takes discipline. And for good measure: http://www.nytimes.com/interactive/business/buy-rent-calculator.html
My parents and I did this when I went to University. I had built up a good savings in the two years between high school and Uni working the rigs and after looking around at the rents people wanted for bachelor apartments I realized I could put a down payment on a three bedroom house and rent two of the rooms out while living in the third and be miles ahead. Problem was I didn’t qualify for a mortgage, and in all likely hood, in the event I came up short on rents my parents would likely be helping out anyway. So they qualified for the mortgage, I had to have a job and make the mortgage payments, unless my studies were suffering, like around exam time and I had to rent out the other two rooms. Never missed a payment cause of the rent, tenants were easy to find since they are everywhere on a uni campus. and we made a little over 30K in 7 years without a tremendous increase in the value of the property, especially when you factor in that the two tenants covered nearly everything. My younger brother was so impressed by how well it went he wanted to go big and get an apartment building, man I wish I had listened to him.
I think there are some important things to consider though, location is obviously huge, in any rent controlled municipality such as Winnipeg or Toronto, this probably doesn’t make a lot of sense, since the rents are artificially depressed in these markets and landlords are forced to provide social assistance the government won’t and a savvy tenant can take advantage of this.
Be well capitalized, and have plans and clear expectations of who will pay what. Especially anticipate the exit. Who gets what from the eventual sale of the house, especially important if you plan to take advantage of the 5% down first home rules and have the student listed as the owner. Bad things could happen if there is a falling out with mom and dad (this is a young impressionable naive kid heading out for there first time, expect poor decisions, including potential drug problems, mom and dad could find the house sold out from under them with very little recourse for them) as well where other siblings are involved, in the event of a catastrophic event that would claim both parents, it is important to have mom and dad on title with a caveat and a joint venture agreement of some kind to protect the other siblings, money and family don’t mix especially after the death of a rich relative, and money is always relative, poor people probably fight as much over the meager estate of poor parents as some rich people do over substantial estates.
Get your childs first term life insurance policy; make sure it is just enough to pay off the mortgage. God forbid it happens but should you lose a child the last thing you need to deal with is the house they were living in in a state of grief like that. you pay out the mortgage with the insurance and deal with the house when you can. Late teens and early twenties it will be cheap, and it beats the mortgage insurance the banks offer in premium cost and payout and it is an opportunity for you teen,twenty to learn. Don’t be superstitious, buying life insurance does not tempt fate.
Include the student in the business nuances with the bank and make them responsible for the bank transactions and utilities. Follow up though as it could affect your credit. It is a great opportunity to educate your children about the pragmatic requirements of life after the pretend and unreal world of University.
After we sold that house, I had a whole new understanding of what was required of home ownership. I took my share of the money from the sale and lived for year and a half in China and obviously rented. When I came back, I only considered renting again for a brief time and bought another home about a year and a half after I got back.
Hope this might help you Sheldon and Sara, like your blog has helped so many.
Regards,
Ian
It’s way cheaper (and easier) just to live in residence. A student shouldn’t have to be stressed out about mortgage payments – usually they are already incurring enough debt via student loans.
If you have enough cash to buy a spare condo outright and rent it to your kid, then go ahead. Otherwise, I think cosigning on a loan is a recipe for relationship disaster (in most cases).