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 struggling financially to get into the market. This is causing them to turn to the “bank of mum and dad” for help.
Naturally, parents want to do what they can for their children and, when it comes to home ownership, there are a number of different strategies that parents can employ to assist. This article delves into these strategies, covering off some of the pros, cons and considerations of each.
A gift
The easiest way to help your children get into home ownership is to gift them money. This will give them 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, lenders see the borrower as a low risk and, as a result, provide a better interest rate and don’t charge lenders mortgage insurance (LMI). We 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 in turn means they will have to borrow less from the banks, reducing the minimum mandatory repayment.
Just be aware, most lenders don’t treat a gift as “genuine savings” unless it’s been in your child’s account for a minimum of 3 months. Genuine savings is typically only needed where the deposit is less than 20%.
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. However, there can be Centrelink implications to consider.
If you are receiving government support, like the Age Pension or the Disability Support Pension, the gifted money will still be treated as an asset under the assets test due to deprivation rules. 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, even if you are yet to apply for a benefit.
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 our blog on financial separation). Given this, some parents prefer to loan the money.
Loan money
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 occurs where there is an expectation that the borrowed funds are paid back.
With any loan arrangement, the terms need to be specified in a written document. You can make the terms 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, 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). If your child is already having issues servicing a loan, this strategy won’t help (the amount borrowed from you will disproportionally reduce the amount available from the lender) . 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.
Guarantor
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 small deposit (sometimes no 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 (commonly real estate) 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, consider the following considerations 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
- When clients ask if they should go guarantor for their children, we often recommend to do so only if they have sufficient liquid assets (like 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) and your portion of the property forms part of your estate upon death.
The benefit of buying a property together is that you are keeping ownership of an asset on your personal balance sheet. This asset has the potential to grow in vale over time but again, may impact your eligibility for government concessions.
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. If not, the full burden will land on your lap. Again, you will want to ensure your child has appropriate personal insurances in place.
If you plan to gift or sell the property to your child at a later date, there will be capital gains tax consequences 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.
Typically, we don’t recommend 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, you should only consider this option if it really is money that you don’t need for your personal financial goals.
Buy through a family trust
Under a family trust arrangement, your child wouldn’t own the property, the trustee of the family trust owns the property. It is then up to the trustees discretion to to let your children stay in the property. 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.
If you transfer the property out of the trust, into the child’s name, this is a change of ownership and stamp duty and capital gains tax implications would apply.
A key downside is that if you want this property to be your child’s principal residence, the property ideally should be held in the child’s name so they can access the main residence exemption for capital gains tax purposes. Also, from your child’s perspective, having a property as part of their personal balance sheet allows them to leverage the equity in the property for future wealth creation strategies.
The Guided Investor approach
One piece of advice that we always give our clients is that, 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. Ideally this means you will be in Phases 3 or 4 of the Wealth Creation process. 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.
If you can’t afford to help your children financially, then help educate them on how to build their own wealth and buy their own house.
All of the strategies discussed 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.
