Your son or daughter has come to you for financial help in buying a home. You want to help, but you are a bit reluctant – you’ve heard horror stories of money driving a wedge between family members. What do you need to know?
Parents often provide financial help to their children in one of three ways:
- Loaning them money
- Providing a guarantee on the loan
- Gifting funds towards a deposit
Each option has its own set of possible pitfalls and factors to consider.
1. Loaning money to children
Loaning money to children can be an alternative to providing a guarantee and putting your own house on the line. But there still are a few important factors you should keep in mind before providing the funds.
- Set ground rules (terms of the loan)
From the outset, everyone should be clear on the terms of the loan. These can include things such as the length of the loan, the loan amount, whether any interest will apply to the loan and a repayment schedule.
- Put it in writing
You need to have the terms in writing and have a loan agreement drawn up. This provides clarity and protects you should things go sour and the need arise to recover the money. A formal written agreement also protects you against nasties such as death and divorce. With nothing in writing, it is difficult to prove your claim in a family court dispute or claim against the deceased’s estate.
- Consider your pension entitlements
If you’re receiving benefits from Centrelink such as the Age Pension, they’ll need to know of any loans you make. Why? Well, put simply, the loan is still considered a financial investment and is subject to the deeming rules.This applies even if you decide to make the loan interest-free – you will still have some income assessed against your pension.
- And… what if the money is not repaid?
If the money is unable to be repaid, it can cause a myriad of issues. The most obvious is that it could put your own finances in jeopardy if you don’t have the money to spare.If you have to forgive the loan, the funds will be treated as a gift for Centrelink purposes and this could impact your pension entitlements.
2. Providing a guarantee on the loan
Did you know that with the help of a guarantee it’s possible to borrow up to a 100% of a property’s value without a cent of a deposit? In fact, some lenders will even allow you to borrow more than the value of the property to cover your incidentals such as stamp duty and legals.
The banks have devised a family guarantee loan, which basically works like this: the parent (or family member) puts their home up as security to cover the shortfall in deposit the children have managed to save.
The banks and mortgage brokers will sell these loans as a great way of getting into the property market sooner and avoiding the costly Lenders Mortgages Insurance (LMI). LMI is where a bank takes out insurance against the risk of loss where less than a 20 per cent deposit is stumped up by the borrower. The cost of LMI can run into the thousands depending on the loan amount and deposit.
Using a family guarantee loan may allow your children to get into the property market sooner, but that doesn’t necessarily mean it’s a smart thing financially.
For the kids, saving a reasonable deposit prepares you for the rigours of paying off a mortgage. It also provides some buffer in the loan should things occur out of the blue, such as losing a job, having a family or getting sick.
By providing the guarantee, you may be sending the wrong message. You could also be putting your own retirement plans in jeopardy if things go sour. If your child defaults on the loan and the bank is forced to sell the property at a loss, your home may be at risk.
You also need to consider other unforeseen events such as what happens if your child’s marriage breaks down? How would the home and associated loan be dealt with in that situation?
3. Gifting funds towards a deposit
Finally, gifting funds towards a deposit or house purchase may be another option that you consider. This may alleviate some of the issues of the first two options; however you still need to be careful, particularly where you receive an Age Pension.
The Centrelink gifting rules mean that you can only gift up to $10,000 each financial year or up to a maximum of $30,000 over five years.
If you gift over these limits, Centrelink will assess the excess amount as a ‘deprived asset’. For example, if you gift $50,000 in one financial year, $40,000 ($50,000 minus $10,000) is defined as a deprived asset. The deprived asset will continue to be counted as an asset and deemed under the income test against your pension for a period of five years.
Remember – money is one of the biggest causes of family disputes. The last thing you want to do is put your own finances in jeopardy by providing help when you can’t afford it. If this is the case, the right option may be to politely decline. No matter how difficult that may be, it could ultimately save your relationship.
Would you provide financial help to your children to enter the property market? Please share your thoughts below.
Information provided in this article is general in nature and does not constitute financial advice. Before making any decision based on this information, you should assess your own circumstances or seek advice from a financial adviser. Wally David is an Authorised Representative (318432) of Wealth Managers Pty Ltd, AFSL No. 232701.