Gift of equity: buying a relative's home with no down payment
With real estate prices rising in recent years, and especially in recent months, it's becoming increasingly difficult for buyers to raise the amount needed for their down payment. This is even truer for young first-time buyers.
However, there are a number of alternatives to the usual approach of saving for a down payment. This is the case with gifts of equity, which act as an important lever for family members, often children, who want to buy back their family home.
What are gifts of equity?
Parents who wish to give their children a financial helping hand can, under certain conditions, offer part or all of the down payment required for the purchase of the family home. This is a completely legal practice that enables the recipient of the gift to acquire a property without any financial contribution.
Considered a traditional down payment, albeit rarer than personal savings, a non-refundable gift must originate from a close family member (father, mother, sister, brother, grandparents, etc.). While gifting is an alternative that can also be used to purchase a new home, gifts of equity relate specifically to the purchase of a property already owned by a family member.
Gifts of equity involve the transfer to a child or close relative of a property owned by another family member, at a reduced price. The cost reduction offered over the market value will represent the amount of the gift and will replace the purchaser's down payment. In all cases, the market value of the property must be appraised by a professional to validate the gift of equity.
In addition to making it possible to acquire a home with no down payment, buying the home of a close relative allows you to avoid paying the welcome tax. In fact, when a property is transferred between generations of direct descendants, such as a parent and child, the new owner does not have to pay transfer duties. It's a great opportunity to save some money!
How do gifts of equity work?
First, it's important to note that gifts of equity only work if the parents (or any other contributor) have equity in their home. This is the difference between the market value and the mortgage balance. The more mortgage payments the homeowner has made, the lower the remaining mortgage on the property relative to market value, the greater the equity available (or net worth).
With a gift of equity, the property transaction is carried out at a lower cost than the market value, although it is based on the latter. The difference between the market value and the sale price will be considered the amount of the gift of equity, which is passed on from the seller to the buyer. This can then be used as a down payment, without the buyer having to take any money out of their own pocket.
A gift of equity can be used for a principal residence, second home, rental or commercial property or land. In most cases, it can be applied in conjunction with other financial assistance programs available to homebuyers, such as the First-Time Homebuyer Incentive, the HBP, etc.
However, there are several rules governing gifts of equity. For most financial institutions, this transaction must occur between members of the same family. The market value must also reflect the fair price of the property: it cannot be artificially inflated in order to increase the amount of the gift. In order to ascertain the true value of the home in question, financial institutions generally appoint a chartered appraiser to provide an objective valuation.
A gift letter signed by the contributor may be required by the financial institution before accepting the request. In addition, the promise to purchase must clearly stipulate the established market value, as well as the sale price chosen based on the amount of the gift.
How is the amount of the gift of equity calculated?
As mentioned earlier, the amount of the gift corresponds to the difference between the actual value of the property and the established selling price. So, if the market value of the house was $350,000 and the sale price was $315,000, the gift amount would be $35,000. This represents a down payment of 10% of the property's value, enabling the buyer to obtain a loan without having to pay a cent out of pocket.
If the gift exceeds 20% of the home's value (over $70,000 in our example), the purchaser may also be exempted from mortgage loan insurance.
There is no obligation as to the amount of the gift. The amount agreed upon could be as little as 5% of the property's value, or any other amount negotiated between family members. It is also possible for the buyer to opt for more than just the gift as a down payment. They may, for example, decide to top it up with their own personal savings.
Buying a relative's home: the importance of fair market value
As with any real estate transaction, the sale of real estate between family members is considered to have been made at the property's fair market value. This fair market value represents the highest price that can be obtained in an open market, between a buyer and a seller acting in an informed, enlightened and independent manner.
Even if the gift of equity calls for the family home to be sold 'at a discount' so that a certain amount can be used as a down payment, the transaction must be based on the property's fair market value. Under no circumstances may the seller inflate the value of the home, or undervalue it, in an attempt to benefit one or the other of the parties involved. Doing this could result in tax penalties for both parties.
In fact, it's also a bad idea to base the transaction on the municipal appraisal value, as this may not reflect the real value of the home. Want to know the difference between a property's market value and its municipal appraisal value? Check out our article dedicated to this topic.
To find out the market value of your family home, the best solution is to call upon the services of a chartered appraiser who is a member of the OEAQ. They will be able to accurately determine the property's current market value. You can then have an informed discussion with your family about the amount you wish to allocate to the gift of equity.
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