A foot in the door.
If your child is looking to enter the property market for the first time, odds are they are facing an uphill battle. Just getting enough together for a deposit is a now a monumental task for most.
In this article, we’ll look at the various ways parents can help their child with their home deposit. And we’ll cover the pros and cons of each.
There are three basic options available to parents when it comes to assisting with a home deposit. They can either gift, lend or go guarantor on all or a portion of the deposit amount.
1. Decide which option is right for you.
Providing a cash gift to your child to boost their deposit is a common and straightforward process. This method has the added advantage of not leaving you exposed to any further financial obligation in relation to the home purchase. Of course, gifting the cash is only an option if you have the money on hand – which many parents don’t.
If you’d prefer to provide your child with a loan rather than a gift, it’s vital you have a written agreement specifying the terms of the arrangement. Having an agreement in place is important for asset protection purposes. If your child experiences a relationship breakdown for example, the court can divide assets between the parties without any recognition of the debt. So having proof that the funds were provided by way of a loan and not a gift, is an important distinction.
2. The magic 20% deposit amount.
Mortgage insurance can be expensive. In some cases, it can be up to 3% of the loan amount. Most lenders will loan up to 80% of the value of a property. So if the cost of the child’s property is $500k, the bank will lend $500k (total cost of the property) but need $625k in security. To raise the 20% minimum and avoid having to pay mortgage insurance, many parents choose to guarantee the additional security against their own property. The loan of $500k is serviced by the kids, not the parents.
While the property remains at a sale price of $500k or higher, the parents’ risk remains low. Lenders differ, but some may need financial details from parents who pledge security to assist kids. If the property increases in value (in this example, to $625k or more) the guarantee can be removed and the parent no longer has an obligation to the lender.
3. Financing your child’s home deposit.
Financing your child’s home deposit is often referred to as a Family Pledge. This has become so commonplace, that many lenders have financial products specifically designed to facilitate this process.
One of the main advantages of a Family Pledge is that parents are acting as Guarantor on the deposit amount – not Guarantor of the loan. This helps to limit the financial risk for the parent. But there is still some risk. By acting as guarantor of the deposit, the parent is responsible for adding security to cover the deposit amount for the child if it’s ever required. If the property is sold at less than the loan amount for instance, the parents have guaranteed the difference.
It’s also worth noting that if parents act as guarantor, they will be required to list the amount as a loan on any future credit contracts. This may limit their ability to borrow for other things in life, because lenders will likely treat them as jointly responsible for the loan.
What to do next?
For more information on Family Pledge providers, email or give us a call to speak with one of our financial fitness advisers.