A helping hand to house kids Parents struggle to know the best way they can get their children onto the property ladder, writes
Jayne Atherton.
MANY PARENTS are mulling how to help the kids buy their first home.
Without that help, they fear the first rung of the property ladder is out of their reach.
And the fear of further price rises can drive a kind of desperation by parents to ensure their offspring don’t miss out.
This week, ACT leader David Seymour said that for the first time, being able to own a property in some parts was ‘‘heritable’’, meaning your chances of doing it depend largely on the wealth of your parents.
So, Sunday Star-Times looked at some of the options:
Gifting the deposit
There are worse things to spend your money on, but many people may fool themselves into thinking they can afford it, when they haven’t secured their own futures yet.
The gift of $30,000 can make a huge difference to a young buyer.
At 6.74 per cent, a $300,000 mortgage repaid over 30 years would cost nearly $400,000 in interest, according to ANZ’s mortgage calculator.
A loan of $270,000 over the same period would cut the interest bill by around $40,000.
Take note though. The parents don’t just lose the money, they lose the opportunity to invest it. Assuming a 3 per cent after tax annual return, $30,000 would grow to nearly $73,000 over 30 years. Risks: The kids lose the house at mortgagee sale and the money is lost to the family. The kids’ marriage ends and the equity in the property is split so half leaves the family. The parents find they need the money they gifted later, or find their retirement is pinched. The aim of this strategy is to help the kids get together a decent deposit and save on interest, while getting the money back.
Mortgages cost more for people with less than a 20 per cent deposit, so this can save a fortune.
The extra cost can be a one-off fee like the 2 per cent fee charged by ANZ for home loans to people with a deposit of less than 10 per cent, or 0.75 per cent for those with deposits of 15 per cent to 20 per cent. Or it can come as higher interest like Westpac’s addition interest of 0.75-1.75 per cent depending on how small the borrower’s deposit is.
This, says Squirrel Mortgages’ John Bolton said parents like loans because they also ensure the money gets paid back should their child’s relationship fail and the assets get divided.
Loans should be properly documented, and there should be a schedule of repayments. Fasttracking the repayment of the loan to a period of, for example, five to seven years limits the opportunity cost losses to the parents. Risks: If the kids hit hard times parents may well feel the pressure to convert loans into gifts. Specifying when a loan must be repaid, limits the lost opportunity of using it for something else. Opportunity costs vary depending on what interest rates, asset prices and the economy are doing. Lending the kids $30,000 five years’ back to help buy an Auckland house would probably mean the kids are equity rich now. Had the parents invested that $30,000 in a balanced KiwiSaver fund for their retirement, and earned 6.5 per cent after tax and fees, they’d have earned around $11,000 on the money. l
Provide a guarantee
There are guarantees and guarantees. Heavy-duty legal advice is needed. Bolton says some banks expect ‘‘unlimited’’ guarantees. These are the bad kind. These are guarantees over the entire loan, and indeed, the most unlimited of unlimited guarantees end up with the parents guaranteeing all the obligations of the kids.
Bolton says the acceptable kind of guarantee is limited to just a portion of the home loan.
If the kids have a $30,000, or 10 per cent deposit, on a $300,000 home, the guarantee might be for the next 10 per cent of the loan, or $30,000.
If all goes wrong, the most the parents would have to pay the bank is $30,000.
Bolton likes to see the guaranteed portion of the mortgage written as a separate loan, in this case for $30,000 to be repaid quickly, perhaps over five years.
Guarantees can be written to be extinguished if the value of the property rises lifting it equity to over 20 per cent of its value.
The beauty of using the limited guarantee is that the parent is using the equity in their home to provide the guarantee at no cost (other than the legal fees), and save their kids a heap of interest by avoiding the low equity fees and margins.
It can save $10,000 in the first year alone, says Bolton. Risks: If the kids’ lives go astray and the house has to be sold, and there is a loss made, then the parents are up for whatever they have guaranteed. The risk can be reduced by insisting the kids have mortgage repayment protection insurance so repayments continue to be made should one or other die, or fall too sick to work.
Be a joint borrower
Parents and kids are co-borrowers and co-owners, each being jointly and individually responsible for making repayments. The parents bring part of the deposit. The kids may be expected to service the loan, but the bank can make demands on the parents. An advantage is that the parents get to see what’s going on, which may not always be the case with guarantees. The moment there’s a missed payment they know. As the kids become wealthier, they can buy out their parents’ share of the house. If the parents bought 10 per cent, and their 10 per cent share is worth more, that can mean them earning a return on their money, unless they just opt to get their cash back. Risks: Mingling finances like this can breed tension in families. In addition, if the kids fall behind in repayments, the bank will come knocking.
Use a reverse mortgage
This is ‘‘a very bad idea,’’ says Bolton. A reverse mortgage (also commonly called equity release) is a loan to the householder secured against the property. The loan can be spent on anything, including lending, or giving it to offspring to help them buy a first home. That can seem like a good idea if the value of your home is rising, and you believe the value of the house to be bought will go up too. $30,000 gifted to a child this way will save them a lot of interest over the lifetime of their mortgage, and may spare them the high price of a low equity fee or margin. But the cost to the parent is high. The interest on a reverse mortgage is high (currently 8.35 per cent at Heartland Bank), so the amount owed rises so fast this strategy is financial madness. A 65-year-old borrower taking out $30,000 would owe just under $69,000 in ten years, and roughly $158,000 in twenty years. Risks: Loss of equity in the home, which may be needed later, and there’s still no guarantee all will go well in the kids financial lives, so the loss could be for nothing.