Summary: Advisers recommend that parents who are helping their children buy a house should always draw up a loan agreement. Parents can stipulate in this agreement that they have a charge over the property the child buys with their help. Methods that can be used to assist children buying a house include a family equity guarantee, a gift or loan, selling liquid assets to acquire an interest in the property, or borrowing against the parents’ own home, although these approaches have varying levels of risk.
Key take-out: Experts emphasise that arrangements based on equity rather than debt have lower risks. Products designed to encourage prompt repayment are also likely attractive.
Key beneficiaries: General investors. Category: Residential property.
The median house price in Sydney is set to pass $1 million by June 2017, according to BIS Shrapnel research. A buyer considering such a property would need to save a deposit of $200,000 to avoid lenders mortgage insurance. Industry insiders say more and more first home buyers are turning to their parents for help. As Robert Gottliebsen has written, an increasingly common option for parents is to buy an investment property and rent it to their children (see Outer suburbs wedded to value, March 25).
But experts also warn parents to consider the potential pitfalls of giving their children a leg up the property ladder, as well as to think about the different options available.
Preparing for the worst
Pitcher Partners partner David Staples and client director, wealth management Jordan Kennedy say that whatever method parents choose to assist their children to buy a home, there should always be a loan agreement drawn up between the parents and the child. Such an agreement can lay out the ground rules of the loan, and the parents can stipulate that they have a charge over the property the child purchases with their help, which restricts the ability for the property to be sold without the chargeholders being notified. This is particularly important if a child wants to buy a car instead of repaying their parents what they owe on the house, for example. Although families trust each other, sometimes they don’t talk enough, Staples and Kennedy say.
A loan agreement helps to protect the family in the case of a relationship breakdown. The child may buy a property with their partner, or they may buy a property on their own and then have a partner move in later. Although parents might think nothing bad will happen, in reality, many relationships come to a natural end, the Pitcher Partners team says, pointing out the issue of fairness for the family’s other children. If one relationship breaks down, half the capital in the property can be lost to the former partner in a settlement, meaning an initial parental gift can partially flow away from the family. This reduces the amount of capital available to the family’s other children to purchase their own properties.
Considering a family equity guarantee
One option to consider is a family equity guarantee. The parents don’t borrow any money, nor do they make a gift. Instead, they offer the title deeds to their house as security for their child. The child can then receive a loan facility with two loans: one loan of 20 per cent of the property’s value, secured against the parental home, and another loan of 80 per cent, secured against the new property. The child pays off the principal and interest on the smaller loan, while also paying interest on the larger loan. When the smaller loan is repaid, the bank hands the parents’ title deeds back to them, and the larger loan switches to an interest and principal arrangement.
Staples and Kennedy say they have seen the strategy work well in practice, as the commercial arrangement puts pressure on the child to repay their loan so their parents can get the title deeds back. “You can’t tug on the heart strings and say, can I pay you next month?”
Although a child in this situation is borrowing 100 per cent of a property’s value, lenders mortgage insurance is not payable as the bank has two properties securing the loan. Of course, this strategy assumes the child has enough income to take on this much debt.
Of course, handing over title deeds as a guarantee is not without risk – and another drawback is that once they have been handed over to a bank, they are unavailable for use by a second or third child, raising issues of fairness.
Declaring your intentions
Parents with spare cash might consider making an initial gift or a loan to help their children with a deposit. Joe Sirianni, executive director of mortgage broker Smartline, cautions parents to be transparent about these arrangements when dealing with a bank. He warns parents not to assure a bank that funds are a gift when they are in fact a loan. The bank needs to understand the child’s repayment commitments to their parents when considering how much additional mortgage debt they can service.
Plus, a letter saying that funds are a gift could be used in court in the case of a child’s separation from a partner to insist the money does not have to be repaid, he says.
Instead, he says parents could specify that their loan has no regular repayments, but the parents expect the loan to be repaid when the house is sold.
Sirianni also notes that some lenders have started to offer products designed for this situation. He mentions the Parent Assist Loan from mortgage provider Bluebay, owned by residential builder ABN Group with funding from Bendigo and Adelaide Bank and Resimac. The loan allows children to borrow a deposit from their parents and take out a mortgage for the rest. The child can either make regular repayments to their parents at a discounted interest rate, or repay their parents when the house is sold. As with a family equity guarantee, the commercial loan structure is designed to make the repayment expectations clear to everyone.
Looking towards retirement
Some parents might consider borrowing money against their house for their children to use for a deposit. Staples and Kennedy warn that by the time children are getting ready to buy a house, their parents are often aged 55 to 65 and thinking about retirement, meaning banks may be reluctant to lend to someone whose working life could be over in five years. This option also comes with the risk that a child could lose their job or face other hardship, meaning they are unable to repay a loan. In such a situation, there is a risk the parents’ home may have to be sold to repay the debt.
Staples and Kennedy say that a slightly less risky method for parents is to sell liquid assets such as shares and use the proceeds to acquire a minority interest in the property, with children borrowing the rest. This allows parents to replace one capital asset with another, rather than taking on debt. A similar approach for empty nesters is to consider downsizing the family home and using part of the proceeds to take an interest in the child’s new property.
They add that parents who are planning to self-fund their retirement may not yet be certain that their nest egg is large enough to support themselves, let alone to provide assistance to each of their children.
Being mindful of family relationships
Staples and Kennedy acknowledge that not every family is able to consider these strategies, saying they hear plenty of stories of children living at home for longer, or parents building a backyard granny flat for their children, then switching places when grandchildren arrive. They warn that if families don’t have good discussions about financial assistance, this can put pressure on family relationships.
Sirianni has four children and the question of financial assistance is a live issue. “I’m very mindful that if I provide support for one, I’ve got to do that equally for the other three,” he says. “Most parents want to help but they want to do it in a way that’s fair and equitable and protects whatever you give your kids from any disruption.”
Although the experts say every family situation will be different, they emphasise the lower risks for parents of arrangements based on equity rather than debt. And products designed to encourage prompt repayment, such as family equity guarantees or Bluebay’s offering, will be attractive options for many parents.