Should You Be The ‘Bank of Mum and Dad’?
The great wealth transfer from the baby boomer generation has begun and home ownership is the catalyst.
The average price of a home in NSW is $1,184,500, the highest in the country. Canberra is next at $948,500, followed by Victoria at $895,000, with the Northern Territory the lowest at $489,2001.
With the target cash rate expected to remain steady at a 12 year high of 4.35% over 2024, the pressure is on parents and family to help the younger generation become homeowners.
Over the last 15 years, home ownership has fallen from 70% to 67% of the population. Over time, declining home ownership will increase the wealth gap in Australia as for many. And home ownership is a significant factor in wealth accumulation. According to the Actuaries Institute, wealth inequality is significantly higher now than in the 1980s, with the wealthiest 20% of households currently having six times the disposable income of the lowest 20%2.
The Domain’s First Home Buyer Report 2024 estimates the time for a couple aged between 25 and 34 to save a 20% deposit for an entry level home to be 6 years and 8 months in Sydney, and 5 years and 5 months in Melbourne (the Australian average is 4 years and 9 months). In that time, they are begrudgingly paying rent (or staying with Mum and Dad).
So, should you help your children buy a home? If they can, many parents would prefer to assist their children when they need it most, rather than benefiting from an inheritance later in life. However, it’s essential that any support does not risk your financial security. That means looking at what support you can afford to provide.
The downside of cash gifts:
A cash gift towards a deposit or mortgage is a simple and effective method of helping a family member. However, there are a few downsides:
- Where the gift forms all or a significant portion of the deposit, lenders may want to ensure that the loan is serviceable and may require verification of the source of the funds to ensure the amount is not a loan and does not require repayment (i.e., a gift letter).
- In the event of a divorce or separation, your child will not benefit from the gift, and instead it will form part of the property pool to be divided.
For income tax purposes, the ATO normally doesn’t tax gifts that a family member gives out of natural love and affection.
The ‘Bank of Mum & Dad’
If you loan your child money to buy a home, make sure you document the loan terms. This should be ideally with help from a lawyer.
There are many ways to structure the loan depending on what you’re trying to achieve. For example, the loan might:
- Mimic a bank loan with interest and regular payments,
- Require repayment when the property is sold or ownership changes, and/or
- Managed by your estate in the event of your death.
There is a lot to think about before lending large amounts of money; what should happen in a divorce, if your child remortgages the property, if you die, if your child dies, if the relationship becomes acrimonious, etc.
As always, hope for the best but plan for the worst.
Providing security to lenders.
You can use a family guarantee to support a loan in part or in full. For example, with some lenders you can use your security to contribute towards your child’s deposit. This avoids lender’s mortgage insurance (which ranges between 1% to 5% of the loan).
When you act as a guarantor for a loan, you provide equity (cash or often your family home) as security. In the event your child defaults, you are responsible for the amount guaranteed. If you have secured your child’s loan against your home and you do not have the cashflow or capacity to repay the loan, your home will be sold.
If you are contemplating acting as guarantor for your child, you need to look at the impact on your finances and planning first. You should not sacrifice your retirement for your child’s aspirations. And, where you have more than one child, look at equalising the impact of the assistance.
Co-ownership.
There are two potential structures for buying property with your children:
- Joint tenants: The property is split evenly and in the event of your death, the property passes to the other owner(s) regardless of your will.
- Tenant-in-common: The more popular option as it allows for proportions other than 50:50 (i.e., 70:30). If you die, your share is distributed according to your will.
Regardless of ownership structure, if you mortgage the property and the other party defaults on the loan, the loan might become your responsibility. It is vital to consider this before loan arrangements are entered into.
It’s also essential to have a written agreement in place that defines how the co-ownership will work. For example, what happens if your circumstances change and you need to cash out? What if your children want to sell and you don’t? Will the property be valued at market value by an independent valuer if one party wants to buy the other one out? It’s not uncommon for children to assume that they will only need to pay the original purchase price to buy your share with no recognition of tax, stamp duty or interest. And, what happens in the event of death or dispute?
If you are not living in the home as your primary residence, then it is likely that Capital Gains Tax (CGT) will apply. It will apply to any increase in the market value of the property on disposal of your share (not the price you choose to sell it for). And, you will not benefit from the main residence exemption. In these situations, it is essential to keep records of all costs incurred in relation to the property. This will maximise the CGT cost base of the property and reduce any capital gain on disposal.
Utilising a family trust.
A more complex option is to purchase a property in a family trust where you or a related company acts as trustee. Parents often use this strategy for asset protection purposes. Typically, at some point in the future, you would pass control of the trust to your child. It might be possible to do this without triggering material CGT or stamp duty liabilities. On the eventual sale of the property, CGT will apply to any increase in value of the property. The main residence exemption cannot be used to reduce the tax liability, even if the child was living in the home.
But, be wary of state tax issues. For example, in some states, owning property through a trust will mean that the tax-free land threshold will not apply, increasing any land tax liability. Also, if the trust has any foreign beneficiaries, this could result in higher rates of stamp duty.
For more information on family trusts, please get in touch with our Aintree Group Legal team.
Reduced or rent free property.
Buying a house and allowing your child to live in the house rent-free or at a reduced rent enables you to put a roof over their heads. But it adds no value to your child’s ability to secure a loan or utilise the equity of the property to build their own wealth.
To claim full deductions on a property your child lives in, charge market-rate rent. Otherwise, the ATO may reduce or deny your deductions. Any rental income received is assessable to you. In addition, you will pay CGT on any gain when you sell the property, or transfer the ownership.
If you plan to leave this property to your child in your estate, clearly document that intention in your Will.
For individual advice, please get in touch with our Aintree Group Wealth team. We are more than happy to discuss your personal and family needs and find the best option for you.
This is general advice only and has not been prepared with your situation and needs in mind. For individual and personalised advice, we highly recommend that you seek out proper professional advice from your financial advisers.
