This month we go to Alan Mortimore from Loanswest our Mortgage expert, for an article on parents helping their kids buy homes, an all to familiar story made clearer.
Despite a patchy customer service history, the Bank of Mum and Dad is soaring to new heights as the property market booms.
And no wonder – conditions are perfect to drive inter-generational lending. Surging prices have made saving for a deposit feel like chasing a runaway train. At the same time, price rises have delivered an equity windfall to older homeowners.
To many, it makes perfect sense for asset-rich parents to offer a leg up to their children. After all, with median home values leaping 13.5 per cent in the past year, the difference between buying now or later can be tens of thousands.
But even with the best of intentions, accepting money from relatives can be a minefield, not least because your average institutional lender is unlikely to ask why you can’t be more like your sibling, or guilt you into spending Christmas at their bank.
And these emotional strings pull both ways.
Recognising a growing need, lenders have developed a range of financial products to smooth the path for family lending that mitigates the financial and emotional risks for parents and children.
Pledge your allegiance
The major pain point for first home buyers is saving a deposit – specifically the 20 per cent typically required to avoid Lenders Mortgage Insurance (LMI), which can add thousands to borrowing costs. LMI kicks in when the loan to value ratio (how much you need to borrow relative to how much the property is worth) sits above 80 per cent. Its purpose is to protect lenders against default on higher-risk loans. But it’s expensive, and avoiding it saves money and can help borrowers access lower interest rates.
Lenders now have products that allow parents to tap into their home equity to help children reach that magic 20 per cent threshold on a property that would normally be beyond their reach. Known as a family guarantee, family pledge or family security guarantee, the loan allows parents to put up security to guarantee all or part of the deposit. Parents’ financial exposure is limited to just this amount, rather than the entire loan.
While many use home equity to secure the loan amount, term deposits can also be used.
Limit financial stress
The key advantage to a family guarantee is that parents don’t need to reach into their pockets to help. And if things should unexpectedly go pear-shaped, they are only liable for the pledged deposit amount. This limits the financial stress and emotional weight of helping out.
Family guarantees, or pledges, also have a limited span. When the LVR of the home loan dips below 80 per cent, the guarantor may be released from the pledge. Rising home values can help tip this balance in your favour earlier than expected.
Sharing is caring
Of course, if the borrower defaults on the loan, the guarantor would become liable for the pledged amount. So it’s vital both parents and children have a clear understanding of each other’s financial situation and obligations. This can be confronting, but a willingness to share financial information allows both parties to enter the arrangement with their eyes open.
Borrowers should also consider income insurance to guard against unexpected illness or job loss that could leave their guarantor exposed.
Acting as a guarantor may impact parents’ borrowing capacity during the lifetime of the guarantee.
Get in touch if I can help your family help each other.
Keeping it in the family
• It’s estimated the informal Bank of Mum and Dad has dished out about $34 billion in loans to help children onto the property ladder, making it one of Australia’s top ten mortgage lenders.
• About 60 per cent of first-home buyers are thought to receive some form of financial assistance from their parents, with an average loan amount of $90,000.
Source: Martin North, Digital Finance Analytics based on a rolling survey of 52,000 Australian households
Ruth is a single mum and has been saving for a home near her parents but was struggling to find one in her price bracket, where she could avoid the need for Lenders Mortgage Insurance. Her parents agreed to use a portion of their home equity to guarantee up to a total 20 per cent deposit on her $550,000 dream home around the corner from them. By doing this, Ruth was able to avoid expensive LMI costs.
When Ruth moved in, her parents were able to help with child-minding, freeing her to accept a full-time role and increase her repayment schedule.
Seven years later, with her increased repayments and a rising housing market, the Loan-to-Value ratio without the guarantee had fallen below 80 per cent, allowing Ruth’s parents to be released from their family guarantee obligations.
Alan is always happy to give advice or provide our clients with a Mortgage health check to make sure they are getting the best Loan for their own personal situation.