Recently we held the second event in our NextWave series, an educational and networking forum designed for adult children of affluent families. Our goal is to provide information on financial matters and help them to better manage their wealth – all in a fun, informal atmosphere. Despite battling beautiful patio weather and game one of the Toronto Maple Leafs vs. Boston Bruins playoff series, the event attracted a full house of young adults keen to discuss renting vs. buying a home.
What’s the right move for you?
The housing market and renting vs. buying has been a hot topic in the Toronto media and we felt a similar buzz amongst our group of young adults on May 1st. After a lengthy discussion about the current state of Toronto’s housing and condo markets, we concluded that due to the uncertainty of whether housing prices will continue to appreciate, the home ownership decision should extend beyond investment-only criteria. Greater emphasis needs to be placed on non-investment related matters: can I afford to buy a home? Does home ownership align with my lifestyle? How does my common law status affect my purchase decision?
The following is a summary of the top issues and concerns that arose from our discussion, which we believe every potential home buyer should understand.
Buy now, upgrade later?
Many first-time buyers purchase starter homes or condos with the intent to upgrade when their financial situation improves, they relocate for their job or simply outgrow their space. But how soon is too soon to upgrade? Flipping your property with a short time horizon can significantly erode any equity you may have built. In many cases, the first five years of mortgage payments can consist of up to approximately 50% of interest rather than paying down the principal, which is not recuperated upon the sale of your home. When upgrading, transaction costs associated with buying and selling must be considered (i.e. moving expenses, land transfer taxes, insurance, home inspection or appraisal costs), some of which will increase as you will no longer qualify for first- time home owner benefits. This inescapability eats into any earned equity and forces sellers to rely on the unknown variable, whether the market value of their home increased enough to cover the associated costs over the shorter time horizon.
Home Buyers Plan – beware!
The Ontario courts deem a couple to be of common law status after three consecutive years of cohabitation (assuming no children are involved). It can be a surprise to many when they learn that the government plays by a different set of rules when it comes to taxation, as couples are considered common law after only 12 continuous months of living together. This can affect first-time buyers planning on using the Home Buyer’s Plan. This is best illustrated with an example: Jack owns a condo and Jill moves in. After a year of living together they decide the condo no longer satisfies their needs and look to upgrade and purchase a home together. Jill, who has never owned a home, has been saving for a down payment in her RRSP account and plans to withdraw the funds tax free using the Home Buyers Plan. Jill is told that she is no longer eligible for the tax-free withdrawal as she is not a first-time home buyer (due to their common law status), and will be taxed on the withdrawal at her current marginal tax rate. To avoid finding yourself in a similar situation and potentially setting back your purchase plans, know the rules and plan accordingly, seeking professional advice if necessary.
What’s mine is NOT yours!
Many people assume that cohabitating couples have the same rights as their married counterparts but there are clear differences, specifically in regards to the home. In a marriage, regardless of who funds the purchase of the home, the matrimonial home will be divided in the event of a marriage breakdown. In Ontario, this is not the case for common law relationships, as property rights do not apply. This can be devastating for the common law spouse (not the homeowner), if the relationship ends and they have been contributing equity towards the home. One suggestion for cohabiting couples is a cohabitation (domestic) agreement. This contract is similar to a marriage contract, protecting spouses and spelling out how property will be split. Domestic agreements are becoming more common but may not apply in every situation, it is best to consult with your legal advisor.
Down Payment – with help from mom and dad
Inflated real estate prices in Toronto coupled with tighter mortgage lending rules is making it increasingly more difficult for young adults to get into the housing market. Many first time buyers are turning to their parents for help and many baby boomers are eager to lend a hand, or more accurately… their wallet.
Love and generosity aside, many families ‘hope for the best but plan for the worst’ and want to know how to protect gifted assets towards the matrimonial home in the event of a marriage breakdown. One of the more obvious tactics is a marriage contract, specifically outlining the division of property. Protection can also be achieved by establishing a trust, where the trust purchases the home or alternatively loaning the funds using a promissory note with no specific repayment provisions.
The same rules apply when using inheritances to make a down payment, pay down the mortgage, or substantially renovate what is, or may be in the future, the matrimonial home. Proper planning on the use of these funds can go a long way in saving potential headaches down the road.
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