For mum-and-dad investors: How to get your child on the property ladder

In the first quarter of 2018, Digital Finance Analytics determined that in more than 52,000 first home buyers, an estimated 55 per cent are receiving financial assistance from their parents, ranging from cash gifts and personal loans to help in paying associated costs such as mortgage repayments and stamp duty.

Since 2010, the number of first-time buyers using the “Bank of Mum and Dad” has increased by 54.7 per cent – that is, from less than 5,000 buyers in March 2010 to almost 25,000 buyers in June 2017. The average financial contribution provided to a prospective buyer has also grown from a little over $20,000 to at least $88,000.

Indeed, the “Bank of Mum and Dad” has risen as “the 11th largest lender in Australia”, with at least $16 billion worth of estimated outstanding balance. As of late, it has come ahead of other major banks and lenders, including HSBC, Citigroup, Heritage Bank, Community CPS, Defence Bank and AMP Bank, in terms of outstanding balance on residential mortgages.

Buying the first house

Of all the barriers hindering prospective buyers from purchasing their first property, it’s surging prices that concern parents the most. This price imbalance is the key factor that pushes them to lend a helping hand to their child.

To put it in perspective: over 40 years ago, you could buy a house in a fashionable suburb near the Melbourne city centre for $13,000. In 2018, buying in the same suburb can cost you over a million dollars.

Salaries, in most cases, have not necessarily kept up with the rising prices. The Real Estate Institute of Australia said that the proportion of median family income required to meet average loan repayments in the 1970s sits between 10 per cent to 15 per cent. Fast forward to 2015 and the figure has risen to 30 per cent.

Here are a few steps parents can take to get their child on the property ladder:

1. Gifting the deposit

Cash gifts are one of the most straightforward means of helping children buy their first property. However, parents must remember that, in most cases, the money they give as gifts must pass the “genuine savings” test to qualify as a home loan deposit.

Most lenders define genuine savings as cash, term deposits, shares or managed funds that have been saved, held or accumulated over three months. Lenders will usually require at least 5 per cent of the deposit amount to be paid through genuine savings.

Gifts, inheritance, savings plans, tax refund, lump sum deposits, bonuses, income from asset sale, First Home Owners Grants, funds from business accounts, borrowed funds and builder’s rebate incentives are not considered genuine savings.

Parents in retirement or in transition to retirement may draw on government pension or super under certain deprivation or gifting rules.

According to the Australian Department of Human Services, the maximum gifting amount for a single person or a couple is $10,000 in one financial year and $30,000 in five financial years (not exceeding $10,000 per year). Going over the said amount may have implications on your assets and income test.

While gifting cash sounds easy enough, experts reminded parents that it may be hard to recover the money they gave their children should they need it for emergency purposes in the future, such as medical treatments. The potential for relationship breakdowns and the possibility of the child passing away before the parents may also pose issues.

To mitigate risks, it is strongly advised to engage a solicitor and regularly review your will and super as well as the structures that hold your assets.

2. Purchase the property

Parents can also opt to purchase the property in their name and have their child rent it at minimum rate. Depending on personal preference, the child can inherit the asset at a given period.

When implementing this strategy, parents must consider that they will not be receiving the full rental income so they need continuous cash flow or enough cash buffer to cover ongoing expenses until the ownership of the property is officially transferred to their child.

Moreover, this might come with potential tax and legal implications, so experts strongly advise engaging accountants, financial planners, property lawyers and other relevant professionals.

Some of the things to consider are tax implications in relation to financial structures, tax on rental income, capital gains tax, annual land tax and credit score implications in relation to life events such as divorce or degenerative illnesses.

3. Sign as a guarantor

By signing as a guarantor, parents may use the equity in their own home or investment property to help their child qualify for a home loan by increasing their borrowing capacity.

Essentially, parents “guarantee” the bank or the lender that their child will be a responsible borrower. However, they gain no property rights from the guarantee and it may also have implications on their own borrowing capacity.

In general, guarantor loans can go up to 20 per cent of the value of the mortgage and may even cover other buying costs such as stamp duty.

Should their child default, the parents will have to repay the loan for them. The banks can demand for up to 20 per cent of the loan amount and if the guarantor is unable to provide it, they can sell the property to recover the costs.

Due to the level of risk associated with this strategy, banks and lenders can deny guarantees from parents if their only asset is the family home. Other criteria may vary from lender to lender and may depend on the child and the parents’ personal circumstances.

Experts advise parents to have a conversation with their child regarding unforeseen circumstances before committing to becoming their guarantor to avoid dire consequences in the future.

4. Co-own the property/buy in partnership

Much like being a guarantor, co-ownership also requires a greater financial commitment from parents who want to help their child buy their first home.

Through this strategy, they can sign as a joint borrower on the loan and own half the property – meaning, they share responsibility for the costs of owning a property while also receiving the benefits of property investment.

If the parents sign as a joint borrower, they have to repay the entire debt with their child, the principal borrower, whether they default on the loan or not.

As good as the idea of sharing the burden of repaying the loan sounds, this strategy comes with a myriad of risks.

For one, since the parents and their child are at different stages of their lives, there might be instances when their plans won’t align, especially in light of big life changes like the child getting married and starting their own family or the parents deciding to retire. One of them might want to leverage the equity in the property to buy more properties while the other may just want to sell the asset. At one point, as in a business partnership, one of them may think, “This doesn’t suit me anymore”.

To avoid any personal disagreements and financial problems, experts advise formulating a “game plan” and documenting it before jumping into co-ownership. Take time to discuss intentions as well as the property’s purpose in order to avoid financial stress until the debt is repaid.

5. Provide personal loans

If the parents decide against gifting for insurance reasons, they may opt to provide personal loans to their child under a family financial agreement. Through this, they can agree to loan a certain amount and sign a legal contract that determines repayment terms, including the deadline.

As this is documented and supervised by legal professionals, it’s considered by many as the less risky option.

Moreover, parents will only be liable for what they shell out. For example, if a child fails to pay a $20,000 cash loan, no bank or lender will come after you and demand that you pay a $300,000 home loan.

However, unforeseen life changes like divorce or death may still cause problems. It may also affect the lending criteria of your child since the bank considers parental repayments when assessing loans.

To make this structure work, engage a solicitor and ensure that both parties involved understand all terms stated in the contract – from the amount of the loan, interest and repayment dates.

Before lending a hand

Understandably, parents want to make it as easy and as smooth sailing as possible for their child, but simply handing over an asset or an investment portfolio is unlikely to benefit them in the long run.

According to property investor Simon Grant, who has two young children, he wants to give them the option of owning a property when they grow up, but not without them understanding the whys and the hows. As young as they are, his children are already aware not just of how money works but also how he plans to expand his portfolio in the future.

“We’ve always had a policy of just being upfront with them. We discuss finances in the household,“ Mr Grant said.

Putting the hard yards into the children while they are young and still at home is one of the key to creating generations of money-smart Australians, the property investor highlighted.

Before giving assistance, parents are advised to have a thorough discussion with their child about how and when the assistance will be provided to mitigate risks. By setting “house rules“, parents and children may avoid any personal and financial conflicts in the future, even when big life changes occur.

Don’t be afraid to have tough conversations with them. Can they actually handle the challenges of asset ownership together with the uncertainties of life? What good is a house if they don’t know how to set goals and prioritise, save money, stick to a budget and manage mortgage repayments, work through the changing property landscape in Australia and set themselves up for retirement?

At the end of the day, the best investment that parents can give a child is education. More than money and property, it is important to give them avenues to develop a good sense of responsibility so they can look after themselves as time goes by.

As they say, give your child not a basket full of gold but the skills and knowledge that it takes to fill baskets with treasures.

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