Think carefully before using hard-earned equity from family home to fund a holiday home.
How parents can help their children into property
First-home buyers are back in the property market at a scale we haven’t seen for a half a decade. They now represent 18 per cent of monthly housing finance commitments, according the ABS, just shy of the long-term average of 19 per cent but much higher than the 13 per cent or so we have seen in recent times.
Despite tough affordability challenges, the cohort has been coaxed back by improved stamp duty exemptions in most states. First-home buyers (FHBs) also have a new ‘bestie’ in the unlikely form of APRA, the prudential regulator, which has handicapped investors, one of their key competitors, with tougher borrowing requirements.
While it is encouraging to see more FHBs succeeding, we clearly have a backlog of young people with thwarted ambition to put their foot on the first rung of the property ladder.
The biggest challenge for this group is saving a sufficient deposit to enter the market. Sure, low interest rates mean they often have sufficient cashflow to afford the monthly mortgage repayments of their target property. But with $80,000 required to fund a 20 per cent deposit on a modest $400,000 entry-level home in many of our CBDs, it is a herculean task to achieve.
Unsurprisingly, around half of first-home buyers resort to obtaining financial help – be it a gift or loan – from parents to fund the deposit, according to 2017 research from Digital Finance Analytics.
Naturally, many parents don’t have the wherewithal to provide such support without experiencing financial stress themselves, which still leaves a lot of young people on the sidelines of the market.
There is a way more parents can assist their children without having to find thousands of dollars of cash. It’s called a limited security guarantee. In short, parents use the equity in their own home to guarantee the difference between what their child has saved and the bank’s usual requirement for a deposit. Essentially, the parents are lending a portion of their credit worthiness. To illustrate, if a bank usually requires a deposit of $80,000 and the child has saved $50,000, the bank will accept just the $50,000 as a deposit on the basis that the parents guarantee to pay the bank $30,000 in the worst case scenario where the child defaulted on the loan and the value of the property fell by $80,000 in a repossession sale.
One of the immediate advantages of this approach is that it usually enables adult children to avoid lenders mortgage insurance – which often cost north of $10,000 even for a modest loan – when the deposit is less than 20 per cent of the target property’s value.
Of course, as outlined above, providing a limited security guarantee is not riskless, although the amount is capped at the defined amount that represents the difference between the notional deposit and the child’s contribution (or $30,000 in the example above).
The best way to mitigate this risk is to choose property that has a track record of and propensity for capital growth. Not only is that self-evidently a good thing, but also the parents’ limited security guarantee typically can be removed once the child’s equity in the property reaches 20 per cent of its value.
This might require the first-home buyers to think more like a return-focused investor when they are looking for the right home, rather than just a single-minded home buyer. But that might well be a reasonable stipulation for a parent to place on their offspring in return for the limited security guarantee. However, do obtain independent financial advice before proceeding.
To watch our video containing further practical guidance, please click here.