Many first-home buyers receive help from their parents to purchase their first property.
There are a few ways that parents can help their children onto the property ladder:
• Gifting some or all of a house deposit• Providing an interest-free family loan with no scheduled repayments• Acting as guarantors for the mortgage (using their existing property as equity)• Buying property with their child as joint borrowers
This article explains how each option works, including pros, cons, and key things to know.
Gifting a house deposit
Parents may choose to give their child a cash gift to cover either some or all of a house deposit.
Banks are in favour of the funds being treated as a gift, as it means that clients are not required to pay back any of the deposit from their parents.
Gifting is also considered less risky for the parents, as it means they will not be liable for any of their child’s mortgage.
Another benefit of gifting is it allows the child to operate independently, for example choosing their preferred bank or mortgage provider.
Example:If a buyer was approved for lending of up to $500,000 but they only have a $40,000 deposit, they will probably be restricted to a $400,000 purchase price (as most banks only go up to 10%). However, with a $10,000 gift from the buyer's parents, they're now able to reach the $500,000 purchase price.
Interest-free family loan
An interest-free family loan with no scheduled repayments is similar to a cash gift. The legal term for this type of loan is a Deed of Acknowledgement of Debt.
Like gifting, there is no requirement for the child to repay their parents by a set time. The debt will be repaid if the property is sold.
With this option (as with gifting), the parents will not be liable for any of their child’s mortgage.
Acting as a guarantor
Parents may choose to use the equity in their property to guarantee their child’s deposit. This may be some or all of their deposit and excludes investment property purchases.
This option used to be fairly straightforward, but it’s become more complicated since the Responsible Lending Act.
The first and most important thing to understand is that banks will not lend above 80% of a parents’ property, which means if the parents have an existing mortgage, it’s essential to crunch the numbers carefully.
Banks also require the parents to meet servicing standards on their debt as well as the debt their child is looking to take on. For older parents who are close to retirement, this can become a major hurdle. Some banks may sign off a limited guarantee, but this is increasingly rare.
Example:If the parents have a freehold (mortgage free) property worth $1m, They would have no issues with the 80% lending rule. They would be able to help their child to secure a 20% deposit. However, banks will require them to show that their income is enough to service the entire mortgage, including the deposit they’re allowing, to be an acceptable guarantor.
Buying as joint borrowers
Parents may choose to buy a property alongside their child and become joint borrowers. This can be a good option if the parents are still working full-time.
A child may be able to use KiwiSaver in this scenario if it’s a property they will occupy (owner-occupied). However, some banks might treat joint borrowing as an investment, as the other borrowers – the parents – will not occupy the property.
Co-owning property can be an attractive option for parents, as they might get a share of the capital gains.
Example:Instead of the banks accessing the parents’ income for their child’s mortgage, banks would use all parties’ income combined to service the mortgage, which makes it easier in most cases. If parents are earning a combined income of $100,000 gross yearly, they may be able to service up to a $500,000 mortgage. However, if the children are also earning $100,000 gross yearly, the serviceable mortgage can now be up to $1m.
Possible pitfalls to keep in mind
Regardless of how a parent helps a child buy a home, it’s important for all parties involved to do their due diligence by seeking independent legal and financial advice.
Possible pitfalls to be aware of include:• Parents’ financial security in retirement• Lack of options available for parents in their retirement• Other parties becoming involved, for example a child’s future partner
• Changes to the property market, e.g. an increase in interest rates or a drop in property values
A mortgage broker can help both parents and children to better understand all of their options.