Many homebuyers struggle financially to qualify to purchase a home. Often I see this with younger clients. Many young people need a little bit of help to get that first home. If they are lucky, they will have generous parents who are prepared to help them financially by providing all or part of the down payment (that portion of a purchase that is not funded by the Lender).
Why Parents Should Have a Second Mortgage
I always recommend to parents who want to help their children with funding that they should take a second mortgage on the property if they expect to be paid back. Having the money secured by a mortgage registered on title is good practice generally. If the children run into financial trouble (e.g. With credit card debt) and can no longer afford the first mortgage, when the property is sold (either by power of sale, sheriff sale or any other mortgage remedy) the parents will get all or hopefully some of the money back.
The Gift Letter
Frequently lenders ask their clients to obtain something called a gift letter from their parents to prove that the owner has equity. The lender is concerned that the money will form a second mortgage on the property. A gift letter is a legally binding document evidencing proof that the money from parents is a gift, not a loan. This is a document upon which mortgage lenders rely when assessing the risk and viability of the loan.
Sign your gift letter
If the funds given to the children is truly a gift, signing a gift letter merely puts into writing the true intentions of the parties involved. The lender can rely on it. The parents have no ability to recover those funds (and do not want to).
Is it a loan?
If the funds provided to the children are actually a loan, and the parents sign a gift letter, knowing that they expect to be repaid, regardless of whether it will also be registering as a mortgage on title, this is not acceptable. Signing a gift letter under these circumstances is mortgage fraud.
A gift letter is a defense against a claim by the parents that the funds were a loan. The parents will find themselves in a very difficult situation. Here are a couple of typical scenario:
- Parents loan money to a child to buy a home. The parents sign a gift letter at the request of the bank. The parents then register a mortgage after the bank to secure the loan. The parents fall onto hard times and ask their child for the money that they loaned back. The child does not want to pay the money back or cannot pay the money back. The child responds that the money was a gift and the parents are owed nothing. The parents now have to sue the child in court on the loan. The child has the gift letter to rely upon and the parents have a registered mortgage. When the parents appear before a judge, they must convince the court that although they signed a gift letter that the intention was for them to be repaid. This would be no easy task because in order to make the claim the parents must admit to mortgage fraud when they signed the gift letter.
- Parents loan money to a child and their spouse to assist buying a home. The parents, child and spouse all agree verbally that this is a loan and they will pay them back as soon as possible. The parents sign a gift letter at the request of the bank. The parents do not register a mortgage because they trust their child and his spouse on the verbal assurances. The child and his spouse divorce or break-up and decide they are going to sell the home. On sale the parents claim a portion of the proceeds against the loan that they all agreed upon (when everyone was happy together). The spouse, now angry at the child and parents, refuses to pay them back. The gift letter is a complete defense against any court action brought by the parents to recover the money.
A loan is a loan. Not a gift.
Signing a document that declares to a mortgage lender that funds provided are a gift, when in fact it is a loan, is fraud. A loan is a loan – not a gift. Do not sign a gift letter under false pretenses to appease a bank. Only when funds truly are a gift should such a gift letter be signed.
How we can help
If you are buying a home and require assistance from your parents for the funds, or if you plan on gifting funds to someone, please contact Real Estate Lawyer, Noah Potechin, at 613-563-6692 to make sure that your transaction is handled properly. For more information, visit our Helpful Resources article on Gift Letters for a Mortgage Down Payment in Canada.