3 ways parents can assist their kids into the property market. Gift, loan and guarantee
With escalating property values in our capital cities especially here in Sydney we are seeing parents helping their children in far greater numbers than ever before.
So how are parents helping their kids?
A common form of parental assistance when buying a property is a monetary gift. Depending on the lender, a letter or a statutory declaration stating the funds are a non-refundable gift is usually required.
The reason for the letter clarifying the funds are a gift is to show the lender that there will be no regular repayments associated with the funds. The gift usually doesn’t need to be transferred until the week prior to settlement however some lenders wont issue formal approval until the funds are in the borrowers account.
Family Guarantee/ Family Pledge
A family guarantee allows the bank to use some of the equity in a family member’s property as extra security for the borrower’s loan. Parents can offer their equity in lieu of the borrower paying a deposit, meaning children can get into the property market earlier. It also removes the need to pay lenders mortgage insurance (LMI).
With most guarantees the parents are only guaranteeing the portion of the loan required to get the LVR to 80%. They are not guaranteeing the entire loan. I guess you could say they are effectively guaranteeing the deposit only.
Case study family guarantee arrangement… Jack & Jill:
Jack and Jill want to buy a home for $1,000,000. They have $80,000 saved up themselves but heir deposit isn’t enough to qualify for a loan as the stamp duty and legal costs alone are $50,000. They have more than sufficient income to qualify for a loan of $1,000,000. Jill’s mum has an investment property that she has no mortgage on, valued at around $700,000. Jill is happy to use this property to guarantee a portion of their loan.
Jack and Jill want to borrow the full $980,000 and they will pay the stamp duty and all closing costs from their savings. Any leftover funds from their savings about $10,000 will be used to improve the property before they move in. The lender needs the loan to value ratio to be 80% so they take a guarantee from Jill’s mum of $225,000.
$980,000 loan / ($1,000,000 value of property being purchased + $225,000 equity from Jill’s mum’s property) = 80%
The guarantee can be released as soon as the loan to value ratio on the property that was purchased reaches 80% or less. This happens when the value of the property goes up and or the loan is paid down.
Parental loans as opposed to gifts are also common. Whether this is legally documented with the aid of lawyers is up to the family themselves but we would say it should be at least documented between the relevant family members in case of dispute later.
For the bank loan application, there will need to be some documentation which outlines the terms and conditions of the loan i.e. interest rate, term of the loan and repayments. If repayments are required they will be included as a liability in the application.
It is also common for the parents to give the money with no expectation of repayments but with the expectation of the money being returned at some stage, usually the sale of the property or from the parent’s estate on passing etc. One idea would be to have an agreement where the loan has “no set term, no repayments required and an interest rate of 0%”. That way the loan would not have to be expensed by the lender but is still documented as money owing.
It’s important to remember that even if your parents can help you in one of these ways, you as the borrower still need to be able to service your loan repayments in your own right.
Also, it is not a free kick to loan approval. If for example you’re on good incomes and living at home but have no significant savings and excessive personal debts most lenders may decide you haven’t shown a responsible ability with money and not approve your loan.
On the plus side it is great way to help get you into the market and can save you significant money by reducing or avoiding mortgage insurance costs.