Bank of Mum and Dad – getting it right
Great article by The Rub highlighting the importance of children in relationships getting Binding Financial Agreements in place to ensure their spouses cannot receive a portion of what the “Bank of Mum and Dad” contribute:
The fall in housing prices has led parents to rethink whether they should open up the Bank of Mum and Dad (BoMAD) for their first home buyer offspring.
Housing prices in Sydney have dropped 10.94 per cent and in Melbourne 9.73 per cent over the last 12 months, according the latest figures from CoreLogic.
This has impacted the number of Australians using BoMAD to finance their first home. According to recent data from Digital Finance Analytics, the number has dropped from over 60 per cent in 2018 to 20 per cent in February 2019.
While these concerns are top of mind, parents should take time to consider the best way to help their children into a home. There are number of important structuring issues to get right, including deciding whether to go guarantor on a mortgage, gift the deposit or lend it, or go into a property purchase as co-buyer. Each has its pros and cons.
Principal of Digital Finance Analytics, Martin North says: “Parents are more concerned in a falling market about the equity in their property, when facing into retirement. The ‘ATM’ has run dry. They cannot afford to pass money down the generation now.”
This drop in property value has decreased the amount of equity available in BoMAD and more parents are unwilling to take that risk and has taken property values back to what they were in 2015 but the decline is ongoing.
“There was a considerable run up to the middle of last year but since then first home buyers who are using the bank of mum and dad has dropped considerably,” North says.
On the other hand, first home buyers may be waiting for the market to bottom off before buying property.
Group executive of financial services at Canstar, Steve Mickenbecker says: “This decrease is probably because mum and dad are saying it’s not a great time to be buying because you will probably be able to buy better in a year’s time.”
According to the Australian Prudential Regulation Authority, BoMAD is ranked among the top 10 lenders in Australia, dishing out over $29 billion to first home buyers and beating out lenders such as AMP Bank and ME Bank.
HLB Man Judd partner in wealth management Jonathan Philpot talks to a lot of clients about BoMAD as a planning issue.
Philpot says: “It’s definitely been on the rise with helping out the children getting their first home, particularly in the last five to six years in Sydney with the market having risen so quickly and the banks wanting 20 per cent deposit.
“Often it’s not considered when people are planning for their own retirement. They are not really factoring in also helping the children with their first home. It usually pops up at the time and I’ve seen a few times where the clients put themselves at a financial risk to help their children.”
Gifting a deposit is a simple way for parents to assist their children in purchasing property.
A drawback for the first home buyer is that this does not show the lender that they can save and if there is a relationship break down, the child’s spouse may be entitled to half the amount.
“In this case it is important for banks to know that this is a gift so that the money is separate from the lending,” Mickenbecker says.
More than half of Resimac’s Generational Property Ladder Survey respondents would consider a gifting cash to their children to purchase property.
Parents need to be aware that this has no protection in getting the money back or in the case of their child’s relationship breakdown.
Going guarantor allows BoMAD to provide assistance without giving cash up front, using the equity in their property instead. Parents will be legally responsible for paying back the loan if the first home buyer is no longer able to.
This quite a popular method for parents as Resimac’s survey saw that 36 per cent of respondents considered going guarantor.
There is substantial risk with this method as it can have detrimental effects on parents’ credit ratings and prevent them from accessing their future credit as the guarantee needs to be disclosed to when applying for credit.
Philpot says: “We strongly discourage going guarantor for children as there is too great a risk for parents who are late in their working life or are retired to be potentially liable for a substantial home loan if the child was not able to meet the repayments.”
It was only last week that Macquarie Bank announced in a note to mortgage brokers that from March 18 it no longer offers family guarantee loans. This marks the first major bank to cease this particular method of mum and dad banking.
ASIC’s MoneySmart recommends that parents consider if they can afford to pay back the loan if the child no longer can and to ensure that they understand the risks surrounding this method.
Co-buying or tenants in common is when parents buy in partnership with their child. The child will own a portion of the property and can buy their parents out later in order to take full ownership of the property.
Around 32 per cent of Resimac’s Generational Property Ladder Survey respondents would consider buying their child’s home in partnership with them.
For extra protection in the case of the parents’ death, it is recommended to buy in joint names or through a family trust so the property would transfer instantly to the child.
“You have to be a party to the mortgage and to the loan and it can be a messy approach as you would be borrowing with your child and in law from the bank and that could affect your future plans and flexibility,” Mickenbecker says.
Loaning a deposit is considered the safest option for parents to protect themselves when assisting their children in purchasing property.
It is recommended that a formal loan document be drawn up, not just a known agreement in order to protect against the child’s relationship breakdown and generally they are written in a way similar to a bank loan and the children pay a small sum of interest so there is a commitment.
“We always recommend a formal loan agreement with a nominal interest rate, rather than gifting the money to the child. It might just be an interest-only loan for 25 years but that’s the protection over what their giving their child over a potential relationship breakdown,” Philpot says.
For some parents, it can be seen as an investment instead of putting money into a term deposit.
“Half the loans we see have been generally a one-year term deposit rate and the parents want to have a financial investment in that regard. Instead of putting that into a term deposit they invest in their children.”
While protecting the parents, this option may impact the bank’s lending and the child will end up with less than if it was a gift or another method.
Mickenbecker says: “The problem that arises is that you need to have this conversation without involving the bank too much as they are likely to say that if it is a loan then they will need to factor that into the servicing analysis of their loan.”
However, millennials should take consideration when taking on debt in a world where wages are not growing as the burden of the debt will not decline.
Omniwealth financial planner Steven Korner says: “People rush into buying a home because they have been conditioned to, but if someone is being gifted an amount from their parents to buy their home, the main concern is that if they can’t save that deposit on their own they may struggle to keep up with mortgage repayments.”
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