Should mum and dad help me buy a house?
The property market may be cooling but it can still be a slog for first homebuyers to scrape together the 20% deposit needed to buy a home without the added cost of lenders mortgage insurance (LMI). This is seeing growing numbers of first homebuyers rely on the support of parents to buy a home. In fact, Digital Finance Analytics estimates that in 2021, as many as three in five first homebuyers relied on mum and dad to get into the market.
But is it a good idea to turn to parents for helping buying a home?
Let me say first up, not all mums and dads are in a position to give their adult kids a financial helping hand. Where that’s the case, other options may be available such as the First Home Guarantee (previously known as the First Home Loan Deposit Scheme), which lets eligible first homebuyers get into the market with just 5% deposit and zero LMI.
However, for parents eager – and able – to help out, there is a variety of ways families can support their adult children to buy a first home. The trick is for parents to be sure they aren’t compromising their own financial security at a time when many may be on the home stretch to retirement.
Gifting a deposit – generous but not always the answer
One option is for parents to gift their child all or part of a deposit. If you have the funds available it can be a very generous step. But it won’t always get a first homebuyer over the line with a home loan.
That’s because lenders usually like to see evidence of genuine savings built up over at least three to six months. This reassures banks that a first homebuyer has the financial discipline to manage home loan repayments. So while a cash gift from mum and dad is always welcome, first homebuyers still need to knuckle down to build a track record of regular saving.
Agreeing to be guarantor
Another strategy is for parents to act as guarantor for their child’s home loan. Not all lenders will accept a parental guarantee, and conditions vary among those that do.
Broadly speaking, a guarantee works by allowing parents to use their home equity as additional security for a first homebuyer’s loan.
No cash changes hands but if a first homebuyer has say, a 5% deposit, mum and dad can offer sufficient home equity to act as additional collateral to make up the remaining 15%. This can get the first homebuyer over the line for a 20% deposit. Over time, the home loan will reach the lender’s particular loan to value benchmark (usually 20%). This can happen by the borrower paying down the loan, the property rising in value, or a combination of both. At this point, mum and dad are usually released from their responsibilities as guarantor.
Make no mistake though, agreeing to be a guarantor involves more than mum and dad putting their signatures on a loan document.
If the first homeowner cannot – or chooses not to – keep up the loan repayments, the lender has the right to turn to the guarantor to make good with the portion of the loan they guaranteed. This has the potential to leave parents financially skewered, potentially forcing them to sell their own home to release the funds necessary to meet their guarantor obligations.
In short, agreeing to be a guarantor is not a decision to take lightly. This explains why lenders usually require a guarantor to obtain independent legal advice before signing a contract agreeing to guarantee a loan. As a parent offering a guarantee, it can be worth asking your child to have income protection insurance in place so that if they are unable to work due to illness or injury, they can at least maintain their mortgage repayments.
There is another aspect to consider in gifting money to your child to buy a home. If they later share the place with a partner and the relationship fails, you could face some highly contentious issues around what happens to the money you gifted to your child. It is entirely possible that your child’s ex could benefit more from your cash gift than your own offspring. Again, this is something to speak with your legal adviser about.
Weigh up the pros and cons
In a nutshell, there are pluses and minuses for families to think through when considering a home loan guarantee.
For a first homebuyer there can be a number of benefits:
- Having a guarantor can be a chance to get into the market sooner, which can be attractive when property values are rising rapidly
- A guarantee can be a chance to avoid the cost of LMI
- A guarantee can even make it possible to borrow 100% of the home’s value.
Mum and dads need to consider that:
- Not all lenders accept guarantees, and some don’t accept second mortgages, which may apply if you still owe money on your home
- Your own home could be at risk if you agree to act as a guarantor
- If the property values decline (something we are seeing in a number of state capitals at present), the guarantee could be in place longer than you expected
- Agreeing to be a guarantor can limit your ability to take out a loan for your own needs.
Family security loans
Other types of family security, or family pledge, loans are available that don’t have to involve home equity.
Westpac for instance offers a Family Security Guarantee, where parents can choose to provide a lump sum of cash rather than home equity to back-up their guarantee. The money is held in a Westpac term deposit, where it earns interest until the loan balance is reduced to the point where a guarantee is no longer required.
Of course, this strategy hinges on parents having the necessary cash available. But it could be a handy option in families with more than one child, as the funds could potentially be rolled from one child’s first home loan to the next as they each enter the property market.
Stumping up a sum of cash doesn’t compromise the roof over mum and dad’s head, and their money is earning a modest return for the duration of the guarantee. Nonetheless, it is important for parents to only provide funds that they are confident they won’t need for the period covered by the guarantee. This makes it sensible to have a separate pool of emergency savings to cover any unexpected bills or emergencies.
Set out the arrangement in writing
No matter how parents decide to support their kids buying a first home – be it a guarantee, a loan of money or a gift, it is worth being aware that if things go pear-shaped, you can lose more than money.
There is no shortage of cases where parents and adult children have ended up at loggerheads, battling things out in the courts to settle a dispute that started when mum and dad tried to help their child buy a property with the best of intentions. These disputes can be financially expensive, and devastating for family relationships.
Having a formal agreement written up by your solicitor that sets out each party’s commitments and obligations – and what happens in the event of a dispute, can be a good idea that helps to protect everyone.
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