ALWAYS CONSULT YOUR INVESTMENT PROFESSIONAL BEFORE MAKING ANY INVESTMENT DECISION
May 24, 2021 | BOMAD
Garth Turner
The venerable Bank of Mom’s been in the headlines again. MSM outlets – TV and print (what still remains) – have been churning out copy on how parental money is the only possible way that adult spawn (many Millennials are now closing in on 40) can get a house.
Here’s an interesting quote in the weekend’s Globe, from the COO of a mortgage company. Fully 60% of clients, she says, are mooching down payments from Mom & Dad.
“They want their adult children to enter the market before it’s too late,” she said. “Parental assistance with living-inheritance giving is the number one driving factor pushing up the prices in Canada’s largest urban markets.”
Exactly. Rather than eschew what they cannot afford, thereby coaxing prices lower, the Mills just Hoover their folks, bid over asking and make the situation worse. It’s always breathtaking what hormones can do. CIBC says average down payment gifts to newbie buyers have increased 58% in two years. BMO reports it’s seeing gifts of up to $200,000. So with first-time buyers typically sucking up more than 50% of all sales in Canada, the BOMAD – not some shadowy offshoring Chinese satellite family – is a prime cause of socially-destructive real estate inflation.
But apart from the impact on real estate, what’s all this gifting of money doing to the retirement prospects and financial security of the wrinklies?
Let’s look at only one aspect: reverse mortgages. Increasingly this is the go-to way for parents to suck off some of their unearned equity to hand over to Junior. Given the meteoric rise in property values, especially since Covid came to town, it seems like this is a simple, clean, quick, low-document way to create money out of nothing. Lenders are reporting a big surge in gifted deposits coming from these things – in fact, reverse mortgage debt is apparently growing eight times faster than that of convention home loans.
What is this?
Wrinklies over 55 can borrow against the paid-off houses, receiving a lump sum which never has to be repaid (until death or sale) and on which no payments are required. Then they give it to kids, who buy more real estate. Besides making the extended family unit that much more financially dependent on the housing market (and feeding home prices), what’s the problem?
Lots.
First, of course, the parents are handing off a chunk of their net worth, represented by home equity. That might hobble them in the future when the money’s needed to pay for essential needs, or perhaps long-term care (which costs a fortune). Or, real estate might tumble years from now if interest rates swell or the economy stumbles, meaning their residential nestegg is wiped out by reverse mortgage debt.
Second, this is a damn expensive way to borrow. Reverse mortgage rates are about double (or more) those of conventional home loans, usually in the 5% to 7% range. None of this interest is deductible from taxable income, either. Bummer.
Third, unlike a regular mortgage – which is reduced with every payment – a reverse mortgage gets bigger every month. Because no regular deposits are made against it, the principal accrues interest at a rapid clip. In fact reverse mortgage debt doubles about every 11 years at current rates. For example, over just 5 years one of these suckers with a cost of 6.34% will add $55,000 to an original borrowing to $150,000. That’s a serious amount of money – all to be sucked out of the property’s ultimate sale price. Plus there are big penalties for paying off this borrowing.
Fourth, reverse mortgages are loans of last resort. They exist for poor and desperate seniors devoid of other options, income or assets to tap into home equity in order to meet basic living needs, finance essential home repairs or pay for medical expenses that would otherwise debilitate them.
They were never intended to subsidize offspring who cannot afford granite countertops and bamboo flooring on their own.
There are better options.
First, if parents really want to help the kids and themselves at the same time, sell the house. Hand over some money, invest the rest in a proper portfolio and let it pay the rent on a nice retirement-appropriate lux condo.
Or, get a HELOC instead of a reverse mortgage. The interest rate on a home equity line of credit is far less. The parents can make interest-only payments, making this a low-cost way of financing a down payment. A HELOC can be paid off at any time – so it’s a great idea to turn the gift to your adult child into a loan. Once they build up more equity, they can borrow against that and pay you back. Of course a line of credit normally comes with a floating (variable) rate, so be aware costs could (and will) rise over time.
Better still, encourage Millennial progeny to save, rent, live within their means, then buy low on the property ladder with a fatter mortgage that Mom & Dad co-sign. That way parental net worth is conserved. The kids learn discipline. The loan gets approved. And you avoid feeding the beast.
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Garth Turner May 24th, 2021
Posted In: The Greater Fool
It used to be that it took only one person, usually the husband, to buy a house. Then as women entered the work force it took two people, usually the husband and the wife, to buy a house. Now it takes 6 people to buy a house: the husband, the wife, the husband’s mom and dad, and the wife’s mom and dad.
I can vouch for this.
In the 1980’s I applied for a mortgage and was turned down because I was single! And yet I was a high school teacher earning a professional salary.
In the 1990’s I told the realtor “I can’t afford your price, you will have to come down”. Reply: “well, why don’t you ask your parents to chip in?”.