Reducing the risk of helping adult children into property
Feedback from readers has revealed keen interest in ways of reducing the risks involved in helping children achieve home ownership.
So crucial is parental support for potential first home buyers that financial institutions are even suggesting funding options to assist home buyers avoid paying costly mortgage insurance attached to purchases with high Loan Valuation Ratios (LVRs).
The highest risk option for parents is to act as guarantor for the child's loan. If things go wrong the lenders can pursue the guarantor for all of the outstanding debt. Calling on the guarantors when problems arise is common practice.
To avoid this possibility, parents need to set an upper limit that they can afford on the assistance provided for the house purchase. Where cash is available, making gifts or documented interestfree loans of specific amounts achieves this objective.
The recent age pension assets test changes have increased the attractions of making outright gifts even of substantial amounts before reaching pension age. After five years, all such gifts are ignored for the pension assets test, effectively killing two birds with one stone.
With the asset test's taper rate reducing pension entitlements by 7.8 per cent of the whole value of assets above a free area, the annual return from gifting money five years or more previously is 7.8 per cent of the value of the gift. The child's mortgage servicing costs are reduced and the combined return to the family exceeds that from investing the money. There is always the risk that the child loses part or all of the money gifted if the house purchase goes wrong but the aged pension entitlement continues.
What if there is no spare cash and borrowing is required? Lenders are now keen to provide a loan on the parents' property which the children can use as a deposit. The interest on the loan has to be serviced but it's a relatively small amount and the debt can be repaid from super at retirement. This loan sets an upper limit on the assistance provided to the child and allows the LVR on the child's mortgage to be kept at a level not requiring mortgage insurance.
The fact that the lenders are facilitating such an arrangement highlights the difficulties facing first home buyers in today's property market. Even if prices stabilise or fall modestly, parental assistance is now a huge factor in the first home buyer market.
The only losers are those with parents unwilling or unable to assist and the problem is daunting for parents with several children. Reducing the demand from investors by gearing and regulatory changes may help but other fundamental changes will be needed to ensure that all Australians are provided with realistic opportunities to achieve home ownership.