What to consider and ways you can assist children in buying their first home.
Having somewhere to live is a basic necessity but the price of Australian property is making it increasingly difficult for young people to purchase a home.
Housing prices in Sydney are recovering fast from the downturn of the past 18 months. The median house price exceeded $1.14 million in December quarter 2019, the Domain House Price Report found.
At current growth rates, Sydney prices will hit new highs in 2020. The story is similar around the country. In Melbourne, house prices are back on track to reach a new peak, while units are already at record highs, Domain’s report shows.
ANZ Private senior financial advisor Jacki Tulloch says parents want their children to save for a home, but realise it now takes much longer to accumulate a 20 per cent deposit – the amount needed to avoid having to pay thousands of dollars for lenders’ mortgage insurance.
“There is a lot of concern that the more [the property market] goes up the bigger the house deposit has to be,” Tulloch says.
Parents with property experience can play a useful role in guiding their children toward home ownership and determining what is affordable.
Those who have the financial means often find satisfaction in transferring wealth to their children during their own lifetime, and helping their kids to buy in an area where they want to live.
“One fear parents have is that their children won’t be able to buy in an area close to them if they don’t help. They’re going to have to buy so much further away but they want to be close to family,” Tulloch says.
Before you help
Even with financial assistance, most young people buying a home need to take out a mortgage. And this can be a beneficial experience.
“Owning your own place and being responsible for your power bills, living expenses, and having to make monthly repayments on a mortgage is a huge financial discipline for people to learn,” Tulloch says.
The first step for the younger generation should be to speak to a lender to assess their borrowing capacity.
At this stage parents will want to rush in and help but what they should first do is consider their own financial needs. A good starting point is to see a financial advisor to determine how much capital to provide their children.
Before providing assistance, most wealthy parents achieve their own financial goals such as:
paying off their mortgage
becoming financially independent
owning a holiday home outright.
At a minimum, parents should generally make sure they have enough rainy day money and are financially comfortable before helping children, Tulloch suggests.
She adds that cash rates and dividends have fallen over the past few years and parents need to determine how the weaker outlook for investment income will affect their plans.
“Are they going to have to use a bit more capital or assets themselves to have enough to retire on?” she asks.
Protect the family dynamic
Parents with more than one child may need to consider whether they will be able to provide similar assistance to each of their children.
Tulloch recommends discussing with kids the fact that “the bank of mum and dad” is not limitless and what is a fair gift for each of the children.
One approach might be to keep a ledger of money given to each child which can be used to adjust what inheritance they get when the parents pass away, she suggests.
Parents need to strike a fine balance between supporting their children, and giving them too much, Dr Melkumian, a financial therapist and founder of US-based Financial Psychology Centre, says.
“I’ve worked with trust fund kids where they were completely taken care of from the get-go and unfortunately it hindered them greatly in their adulthood, in their professional lives, because everything was taken care of. They’re not used to having a work ethic,” he says.
Where that balance lies will be different for each family, but whatever the level of assistance, parents should consider documenting their reasons for giving, Dr Melkumian says.
The contents of such a document would vary from family to family: “Overarching themes could be discussed such as: ‘Are we buying this as a way to show our love for our child? Or is it also a practical step for our family and a legacy?’.”
Writing down each parent’s emotional goals in providing financial assistance allows parents to share their expectations with each other and with their children. This can help prevent feelings of resentment, guilt and shame, and protect the family dynamics if something goes wrong, he says.
Practical strategies to help
The next step is to decide how to provide the funds. Financial, legal and tax advisors can help determine the best approach, addressing questions such as:
What will the tax implications be?
What if the child’s marriage or relationship breaks down?
What if the child becomes ill or loses their job?
What if the child’s business fails?
A simple gift
The simplest option, says Tulloch, is often to gift money.
There are generally few tax consequences for either parent or child with a gifted sum and there may be no legal structures to establish. (Parents should seek professional advice to confirm the implications of a simple gift.)
The biggest drawback is that parents have no right to reclaim the money at a later date. This may lead to regrets if the child’s marriage or relationship breaks down, as the child’s partner may be entitled to half of the assets, including the gifted sum.
Similarly, if the child has a business that fails, creditors may be entitled to those funds.
Lending to children can achieve a similar outcome to gifting but with greater protection, says Brennan Solicitors’ Paul Brennan.
By structuring financial assistance as a loan – even if the parents do not intend to ask the child to repay the debt – the parents have the option to recall the money.
Reclaiming the money would allow the parents to return it to their child later on, after the reason for recalling it has been resolved. A loan can be forgiven on the parents’ death.
Establishing a loan is more costly than gifting money as it’s essential that the loan is correctly documented.
“You’ve got to see a lawyer,” Brennan says. “You can take a chance on all sorts of things but not this. You’ve got to have a lawyer do this because if you don’t it will just bite you on the backside later on.”
Having the loan secured by an asset – such as the property – can help to ensure funds can be made available to repay the loan if required, Brennan says.
Another way parents can help is to guarantee the child’s mortgage. This allows parents to provide assistance without giving cash up front by using their own income or the equity in their property to secure the child’s loan.
A guarantee may allow the child to borrow more than they otherwise could.
However, Tulloch says parents are rightly cautious of this approach as they are faced with repaying the loan if the child defaults.
“You would want your child to have shown they can save and be quite responsible for their money before you put your house up as security,” she says.
Parents may need to pay for costly independent legal advice before entering such an arrangement.
Another risk is that if the child buys the property in joint names with their partner and the relationship fails, the child could lose half the house but the parent would remain guarantor for the full value of the loan.
Parents should also be aware that acting as guarantor affects the amount they can borrow for other purposes as lenders consider guarantees as borrowings when determining how much to lend.
Some parents buy in partnership with their child with the intention that the child could buy them out at a later date to take full ownership of the property. The property may be owned directly or through a trust.
This may suit some families but Tulloch says it’s generally not popular as it prevents the child accessing first-home-owner grants and the parents may be required to pay capital gains tax when the property is sold.
Whichever method parents are considering, Tulloch suggests they should encourage their child to put in place an estate plan and take out adequate insurance cover, with income protection and trauma insurance being the most important to consider.
“If you have loaned them the money you have certain rights in making sure they’ve got their finances in order,” she says.