A reader of the last newsletter, George, asked for an article in relation to helping adult children to purchase a house with a reference to asset protection.
For most aspiring first home owners, the biggest barrier to home ownership is the deposit. Even with 95% loans, you need $20,000 plus costs (stamp duty, mortgage insurance titles office fees, bank fees and legal fees) – around $40,000+ all up assuming a $400,000 property.
Cash Gift If a parent has the cash, a cash payment to the child is a simple way to assist. However, even then, there are issues to consider:
- A cash payment to a child will legally be presumed to be a gift unless there is evidence otherwise. If the money is intended to be a loan at least a simple loan agreement should be put in place; and
- If the parent is in receipt of a pension, the pension impact of any gift should be considered;
- Some banks require evidence of savings from borrowers – a cash gift may not satisfy this requirement.
Preparing a loan agreement with a defined interest rate and repayment terms will also assist to retain the funds within the family should the child become insolvent or suffer a major relationship breakdown – as long as the terms of the loan are broadly complied with and the loan hasn’t evolved into a gift.
Where a parent has equity in the family home, but no cash a common solution is for the parent to simply guarantee the child’s loan and provide the family home as security.
The attraction is, all things going well, the otherwise unused and cost free equity in the house can be employed to get the child into the property market.
However, if things turn sour, the parent is likely liable for the entire balance of the loan and there is generally nothing to stop the bank selling the parent’s home to recover the debt leaving the parent to sort out the mess with the defaulting child.
A recent refinement is for the parent to provide a ‘family guarantee’. The idea is that the loan is in the child’s name but the parent provides a guarantee limited to say 20% of the loan (plus interest and fees) and a mortgage over the family home – again limited to 20% of the loan.
Where the parent already has a mortgage this will mean that the child borrows from the same bank or the parent refinances so that both loans are with the same bank. This requires that the parent has sufficient equity in the family home.
On the other hand, it should assist the child to avoid lender’s mortgage insurance – which typically applies to loans for more than 80% of the value of the property being purchased.
Naturally, these issues become more complex where a parent has more than one child or if a parent wishes to use the equity in the family home for their own investment or other purposes.
An increasing issue in our society is ‘elder abuse’. That is, in this context, parents being bullied, one way or the other into providing financial assistance that the parent is not comfortable with.
The current tax environment encourages first home buyers to purchase the biggest and most expensive property they can. After all, the stamp duty cost of moving is increasingly prohibitive and recent history teaches us that property is a one way bet – so buy the biggest house possible!.
This leaves many children needing for help to get started and parents looking to help their children get ahead. However, it is important to get the details right so that the parent understands the risk they are taking and the underlying personal relationships are not damaged.