The dream of home ownership is still alive and kicking here in Australia but thanks to high property prices, a lot of young people are shying away from buying a home.
The recent downtrend in prices, due to rising interest rates, may have sparked a little more attention. However, unfortunately this interest has been offset by the cost to service debt, which is getting harder as rates rise.
This is causing a lot of young adults to look to their parents for guidance and financial assistance with entering the property market. Naturally, parents want the best for their children, so they are considering what they can do to help their children buy property.
Today we are going to talk about some of the ways that parents can help their children enter the property market. Each method comes with its own pros and cons to be considered.
Before we jump in, I just want to tell you what I tell many of my clients – you should only help your children if you are in a position to do so.
Think of it a bit like putting your oxygen mask on the plane. The flight attendant will tell you to put your mask on before helping others because if you can’t look after yourself, you’re going to be no good to anyone else. It is the same with your finances.
Make sure your own financial position is solid and you are in surplus of what you need to achieve your own financial independence goals before helping your children. As a parent, you have already given them life, the best upbringing you could, love and affection. Anything financial on top of this is just a bonus.
Now with that said, lets jump in!
The easiest way to help your children get into home ownership is to gift them money. This will help them have a larger deposit than they otherwise would.
When it comes to buying a home, it is ideal to have a minimum 20% deposit plus costs. At this level the banks see you as a lower risk and as a result you get a better interest rate and not pay lenders mortgage insurance (LMI). We will discuss other ways to get around LMI later.
By gifting your children money, they can get closer to, or event exceed, the 20% deposit. This will also mean they have to borrow less which makes their repayments smaller.
Just be aware that most lenders won’t treat a gift as genuine savings unless it’s been in your child’s account for a minimum of 3 months.
There are no tax implications of gifting the money – you are free to gift your children money without them having to pay any tax on the gift. One thing you do have to be very aware of before gifting money is that there can be Centrelink implications.
If you are receiving a government pension, like the Age Pension or the Disability Support Pension, the gifted money will still be treated as an asset under the assets test. You can only gift $10,000 in a single financial year or $30,000 over 5 financial years (find out more about gifting). Anything in excess of this will be treated as an asset for 5 years.
Another key risk with gifts is that if your child has a spouse and they separate, that gift will likely form part of the asset pool when splitting money (check out the blog on financial separation). Given this, some people prefer to loan money so we will talk about that one next.
If you want your child to pay back the money that you give them, or if you want to protect the money in the event of separation, you can consider a loan. A loan is where you give a lump sum of money and there is an expectation that it is paid back to you.
With any loan arrangement, the terms need to be specified in a written document. You can make the terms basically anything you want, but you should involve a lawyer to help draft the contract to ensure it is binding.
In the event of separation, funds subject to a loan agreement would be considered a liability in family law proceedings and be repayable to the parent in full.
Just be aware that if you do loan the funds to your children, lenders view this differently to a gift and will factor it into the child’s serviceability (meaning they can borrow less from the bank). This may be an issue if you are loaning funds to your child because the bank won’t lend enough to them. In this situation you have to ask yourself, should you be encouraging your children to take on that much debt anyway?!
The same Centrelink issues and genuine savings issues apply to a loan which we discussed in gifting.
Under a guarantor arrangement, you are putting up assets as security for your child’s loan. This reduces the risk for the lender and therefore your child can benefit from getting a loan with a smaller deposit, no LMI and a good interest rate.
One of the most beneficial elements of a guarantor arrangement is that it is a way to assist your children without handing over any cash. You simply put up an asset as security and wait until your child’s loan drops below an 80% loan-to-value ration (LVR) before removing the guarantee. However, there are some serious consequences if things go wrong.
If your child defaults on their repayments, the lender would sell their house to pay out the debt and if that is insufficient, they would then potentially sell the guarantors asset to recoup the difference.
Given the seriousness of the consequences, I would recommend the following before going guarantor:
- You are confident in your child’s ability to handle money and meet their loan obligations;
- You ensure your child has appropriate insurances in place to cover the debt in the event they were unable to work (Life, TPD, Trauma and Income Protection); and
- I personally would only go guarantor if I had sufficient cash to cover the guarantee amount. This way if the lender did come for the asset, you can cover the shortfall without needing to sell your property.
Buy a property together
Some parents choose to buy a portion of the house that their children are going to live in. They can do this as joint owners or tenants in common.
The primary difference between the two ownership styles is that joint tenants is always an equal share and the property will automatically revert to the surviving owner(s) upon death. Under a tenants in common arrangement, the split can be anything you like (ie 50/50, 60/40, 90/10, etc) and your portion of the property forms part of your estate upon death.
The benefit of buying a property together is that instead of just giving your child money, you are still keeping an asset on your own personal balance sheet. An asset which has the potential to grow in vale over time.
You could enter into this arrangement with the intention that your child buys you out in the future, with a view to sell the property at a later date and split the proceeds, or you may decide to gift this to them as part of their inheritance. I would suggest speaking with a lawyer about a Co-Ownership Agreement to document your intentions and provide better certainty.
One thing to be very careful with in this arrangement is that both parties will be liable for the full loan amount so you want to be very certain that your child can maintain their repayments. Again, you want to ensure your child has appropriate personal insurances in place.
Just be aware, if you plan to gift or sell the property to your child at a later date, there will be capital gains tax issues and stamp duty concessions to consider. Your child’s eligibility for any first home buyer benefits may also be impacted so you need to look into this with your local state government.
Personally, I don’t like buying asset with anyone other than a spouse. Although you may be very close with your children, your financial goals and objectives will go down very different paths as you get older. Given this, I would only consider this option if it really is money that you don’t need for your personal financial goals.
Buy through a family trust
I deliberated whether I should include this one in here because buying a property through a family trust is not really helping your children to own property. The trustee of the family trust owns the property.
You can then decide to let your children stay in the property at the trustee’s discretion. This could be on a rent-free basis, or you may agree that some rent will be payable.
The benefit of this approach is that as the trustee or Director of the corporate trustee, you maintain full control over the property. If you were to pass away, the trust deed prescribes exactly how the family trust will operate and each party’s role in the trust. Effectively the control of the trust can be transferred to your children without incurring capital gains tax or stamp duty.
A key downside is that if you want this property to be your child’s principal residence, the property really should be held in the child’s name so they can access the principal residence capital gains tax exemption.
Also, if you intend to eventually transfer ownership to them, there will be stamp duty and capital gains tax issues to consider.
We have covered off a number of the ways you can help your children to buy property and some of the pros and cons of each method. If you are considering one of these methods, please ensure you do further research and get the appropriate advice from a licensed professional.
In my opinion, one of the best things you can do for your children is to educate them on how to build their own wealth and buy their own house.
All of these things we discussed today are good, and can benefit your children if you are in a position to do so financially, but nothing beats good old fashion financial education. Instead of given your child a fish, teach them how to fish. If you aren’t great at fishing yourself, put them onto someone who is like a Financial Adviser.