Over the past few years, in Australia we have seen an increasing number of parents helping their children to buy a home.
Initially, this trend was driven by rapidly escalating property prices and the desire to help their children purchase a home whilst it was still affordable.
Of more recent times, with a more stringent approach to serviceability by Banks, the focus of parents has been more about reducing the amount borrowed to help make the repayments more affordable.
There are several ways parents can help their children buy a home, with each having pros and cons:
Parents can help their children buy a home - A non-repayable gift
The most common way parents can help their children buy a home is to provide a non-repayable gift. This can:
- Reduce the amount borrowed
- Help make the loan repayments more affordable
- Remove the need for Mortgage Insurance. (Mortgage Insurance is generally required if the total equity contribution is less than 20% of the purchase price)
A major benefit for the parent(s) providing support by way of a non-repayable gift is that they assume no legal responsibility for the loan!
Most Banks will require a Statutory Declaration that the gift is non-repayable. This can:
- Reduce the amount borrowed
- Help make the loan repayments more affordable
- Remove the need for Mortgage Insurance. (Mortgage Insurance is generally required if the total equity contribution is less than 20% of the purchase price)
A major benefit for the parent(s) providing support by way of a non-repayable gift is that they assume no legal responsibility for the loan!
Most Banks will require a Statutory Declaration that the gift is non-repayable.
The downsides of contributing as a gift include:
- The parents have no say in as to the future of the property or additional borrowings
- If the child is in a relationship that breakdowns, the equity contribution could be lost, or diminished, by the disbursement of assets
Providing a Loan
Another way parents can help their children buy a home is to loan the funds to the child.
In this case it is important the terms of the loan is documented:
- How long it is for
- When it is repayable and under what circumstances
- If monthly or other repayments are required
- If interest is to apply. At what rate, and when or how the rate may be adjusted
- What happens to the loan in the event one or both parents pass away
If going down this path, to avoid issues and/or family disputes etc down the track, it is important to involve a solicitor to ensure the terms of the loan are properly documented.
In the event additional funding is required for the purchase from a Bank:
- The Bank will need to be satisfied with the terms of the parent’s mortgage
- The parent’s loan will rank behind the Bank’s mortgage (That is, in the event of default the Bank will be repaid first)
(Generally, Banks do not favour Home Finance that is subject to multiple mortgages)
Providing a Guarantee
For parents that are asset rich but cash poor, providing a guarantee to support the borrowing may be an option.
Today most Banks will accept a limited guarantee. That is; the parents agree to provide support and accept responsibility for a percentage of the loan.
In our experience this is 20% of the loan value plus Stamp Duty and fees.
Depending on the circumstances the guarantee may need to be supported by a mortgage over property that parents own.
In some circumstances, a guarantee to cover the full debt may be requested. However, such arrangements are not generally favoured by Banks. The reason being, that should the child default on the loan, the parent (guarantor) can be called upon to repay the total debt. This could potentially include the sale of property owned by the parent!
Depending on the Bank, the parents may also need to show they can service the debt (to the level guaranteed) from existing income should the need arise.
It is important to note however, that even with the parental guarantee, the borrowers will still need to demonstrate they can service the total debt from their existing income.
Before signing a guarantee, it is essential to:
- Understand exactly how it works and your responsibilities
- Have the guarantee and loan documentation reviewed and explained by a solicitor.
Another way parents can help their children buy a home is to take part ownership in the property being purchased. This can provide parents greater control and say as to the future of the property.
However, it will also mean the parent will share responsibility for the debt and its repayment.
The parent will also need to show to the Bank they can service and repay the loan from existing income.
Other downsides also include:
- Unless the property is the parents primary place of residence it is likely to be subject to capital gains tax
- It may exclude the child from accessing any First Home Buyers grant that may be available
Place money in a Mortgage Offset Account
A further option parents can consider to help their children buy a home, is to place money into a Mortgage Offset Account
Here, the child would need to come up the initial deposit, but the parent can lodge funds in a Mortgage Offset Account to reduce the repayments.
The risks here are:
- The money will be in the child’s name and they can access it should they desire
- If they are in a relationship that breaks down – the funds may be considered a joint asset of the parties in that relationship
- In the event of default, the Bank may take control of the funds to reduce the amount owing
Summary
In a market of high property prices and low wages growth it is a natural desire of many parents to help their children buy a home.
However, it is important before taking this step to understand the ramifications of the different options available. To seek professional advice.
If you would like to learn more, don’t hesitate to call me
