20 Feb 2017
Helping children buy a home while protecting parents
According to Mortgage Choice’s 2016 annual First Home Buyer Survey, 4.9% of all first home buyers had a parent or immediate family member go guarantor on their home loan, up from 3.9% in 2015 and 3.8% in 2014*.
December 2016 saw our capital city dwelling values rise by 1.4%, taking the annual capital gain for 2016 to 10.9%; the highest growth rate for a calendar year since 2009^. With ever-rising property prices outstripping wage growth, it is no wonder few prospective first home buyers can purchase a property without family financial assistance.
Gift, loan or other?
One way to help adult children buy a home is providing a monetary gift to help with a deposit. The problem with gifting is that the money is not protected in the event your child is married or in a relationship, and your child and partner then separate or divorce. In the event of a relationship breakdown, the gift becomes part of the joint assets of the relationship. Another issue with gifting is where parents intend to receive the age pension within the next five years. Any asset or amount over or above $10,000 gifted by a single person or couple in a single financial year or above $30,000 over a five year rolling period impacts on parents’ pension entitlements for five years.
A better way to provide support and to protect parents’ interests may be through a written loan agreement. Even though children may view this as an expression of distrust, a written agreement would give all parties certainty about what has been agreed and what is expected of everyone. It would show the family that they are serious about repaying the loan. A loan agreement would ensure that the parents’ rights are protected in the event a child’s relationship with his or her spouse or partner broke down. It would also be helpful in preventing sibling jealousy with respect to parents’ assets and future inheritances.
Another option is for parents to provide guarantor support for their children by providing either the parents’ home or term deposits as security. Financial institutions offer a variety of options. The Commonwealth Bank has a facility called Guarantor Support, which would enable a child – through parental support – to borrow more funds than they could otherwise or purchase the property that they want rather than having to settle for a cheaper alternative.
Finally, parents could consider buying the property jointly with their children, but this would mean the parents would have their names on the title deeds. For both guarantor support and joint ownership of property, parents need to be aware that they are fully liable for their child’s loan obligations.
As further protection, parents who gift or lend money can insist that their child and spouse or partner enter into a binding financial agreement to ensure that the gift or loan is repaid if the relationship fails. These agreements can be made either before or during a marriage or de facto relationship.
Parents should always obtain specialist legal and taxation advice when setting up a loan for their children.
That said, here are some options to consider:
- Should the loan be on interest free or commercial terms? Generally speaking, the more commercial the terms of the loan, the more likely the courts will be to view the loan as neither an asset of a relationship between a child and spouse/partner nor a financial resource of the child. The child should make repayments of the loan principal or pay interest at least annually.
- If interest is charged, will it be fixed or variable or pegged to a bank interest rate?
- Should the loan be open ended or does it need to be repaid within a certain time frame?
- Should parents request security over the debt, even though the agreement is classed as a personal debt?
On the last point, one practical form of security is a caveat over the property. A caveat simply provides notice that a person claims a particular unregistered interest in the property, but it is not as powerful as a mortgage, which creates official rights over the property. In a bankruptcy context, failing to take security over the child’s assets may mean that other creditors get paid before the parent.
The importance of life insurance
Regardless of the way parents decide to financially help their children purchase a home, life insurance on the lives of children and even their partners should be considered. If illness, injury, or even death were to happen to an adult child who had just purchased home, it would be quite likely that the child – even one with a spouse or partner – would have trouble meeting mortgage repayments and could possibly even lose the home. The consequences would be compounded by the fact that the parents have provided funding, one way or another, with a potential impact on their retirement plans.
However, given that the child has just spent all his or her savings on the home purchase and associated costs, life insurance affordability would be an issue. Given this minimal cash flow, parents can also assist in this area, particularly as this would protect both themselves and their children. With lump sum covers (term life, TPD and trauma cover), the easiest way to do this is to set up a non-super (ordinary) life policy owned by the parents on the life of the child. This ownership structure would satisfy CGT exemptions under section 118-300 ITAA97 for term life (as the parents would be the original owners of the policy) and section 118-37 ITAA97 for TPD and trauma. These exemptions would also apply for cover over the life of the child’s spouse or de facto partner, so all lump-sum insurance proceeds would be tax free to the parents.
The good news is that given the age of the children, insurance premiums should be relatively low. The level of cover should at least be the amount of the loan or gift, so that the parents would not have a shortfall if an insurable event occurs. Income protection for the child should also be considered. This must be owned by the child to ensure that a tax deduction can be claimed, but of course the parents could also help out financially.
Once the loan is repaid, the parents have the option of transferring the ownership of the insurance cover to their adult children, so they could assume premium payments.
Most parents naturally want to help their children get started in life, and often provide some kind of financial assistance to help with a property purchase. Life insurance on the adult children should be considered in order to provide protection against unforeseen illness, injury or even death. The initial premiums can be paid by the parents and are relatively affordable given the age of the lives insured.
If you wish to get in touch and discuss further, contact us here.
* Mortgage Choice media release 15 September 2016 titled Parents forced to help their children onto the property ladder, accessed 5 January 2017 at https://www.mortgagechoice.com.au/news/media-releases/parents-forced-to-help-their-children-onto-the-property-ladder.aspx
^ Core Logic article titled Capital city dwelling values surge 10.9% higher over the 2016 calendar year, by Tim Lawless, accessed 5 January 2017 at http://www.corelogic.com.au/news/capital-city-dwelling-values-surge-10-9-higher-over-the-2016-calendar-year