The Bank of Mum and Dad
How to Assist your Children to Buy their First Home
Most lenders like to see a borrower have a deposit of at least 20% of the value of the security property. If the amount of the deposit saved is less than 20% then, generally, the lender requires the borrow to take out lender’s mortgage insurance which can become quite expensive and this can be an impediment to the loan being granted. One way to overcome this issue is for parents to provide a guarantee for a fixed amount which will take the deposit saved and the guaranteed amount to over 20% of the value of the property which is being purchased. Most of the major lenders have this type of product. The benefits are:
- It enables the borrower to secure a loan (and secure a property) which they may not otherwise been able to do;
- It does not require the guarantor to advance any moneys;
- Whilst it requires the guarantor to offer a mortgage as security for the guarantor, it would be most unlikely that the guarantor would have to sell their property to rectify any default on the part of the borrower because, generally, if there is a default on the part of the borrower, the banks or other lenders require the principal security property to be sold and only if that sells for an amount which is not sufficient to discharge the whole of the loan will the lender seek a remedy from the guarantor;
- Provided a guarantor ensures the amount of guarantee is limited to a specified amount the guarantor’s exposure is limited. On the other hand (and this would not be advisable), if the guarantee was unlimited then the guarantor could be liable for the whole of the loan amount.
There is a downside. If a parent places a mortgage over their home to secure the repayment of a guaranteed amount then, although there is no immediate demand for payment, there is a potential obligation to pay up to the limit of the guarantee and banks tend to view this as an actual obligation to repay rather than a potential obligation to repay. This means that it could restrict the guarantor’s ability to further encumber their security property in order to do other things or it could create a few practical issues if the guarantor decided to sell their property before their guarantee obligations had been discharged. In that case, they would either have to transfer the mortgage onto the new property or place an amount for a little more than the extent of the guaranteed amount in a term deposit whilst the guarantee remains in place.
We strongly recommend that parents who do assist their children in this way extract a promise from that person to make additional payments in order to reduce the amount of the loan as quickly as possible so that when the ratio of borrowings to lend value is 80% or less the borrower can make application to have the guarantor released from their obligations.
Sometimes people ask “Can’t I just lend the money to my son/daughter?”. The answer is yes but this can create a number of difficulties such as:
- There might be more than one child and the gift of money to one might cause family disharmony.
- The recipient of the gift may enter into a relationship which, after a time, breaks down leaving the ex-partner/spouse able to make a claim against the money gifted. 2
- If the parent is a pensioner or shortly to be a pensioner, then Centrelink will apply deeming rules which prevent the pensioner or potential pensioner from giving away more than $10,000 a year or $30,000 over a five year period.
If you have any questions on this issue please call us on 9543 1444.