The Bank of Mum and Dad

Welcome to my Winter Newsletter where I discuss topical issues in the Mortgage / Property space.

Recently I have been getting a number of calls inquiring about how parents can help their kids purchase a property. This seems to be driven by a combination of factors, the recent cooling down in the property market, increased number of first time buyers re-entering the market, Reserve Bank restrictions on what banks can lend and good levels of KiwiSaver savings available.

New Zealand home ownership rates have been dropping steadily for years, from around 74% in the early 90s to around 63% now. Most people agree home ownership is good for everyone as it promotes strong communities, provides financial security and it’s a natural desire for parents to want to try to help the kids via the “Bank of Mum and Dad” into home ownership. The Reserve Bank rules limit the amount of money banks can lend to anyone wanting to borrow more than 80% of the value of an existing property to 15% of the banks total residential lending. In reality from what I see banks are sitting at between 8% to 10%. This is mainly due to the way the bank assesses these applications. When comparing loans of over 80% to loans of less than 80% lending the bank will require a borrower to demonstrate a great capacity to meet the mortgage payments, charge a higher interest rate, require a registered valuation and will only issue conditional approvals for actual property purchases rather than a general “pre-approval”.

This equates to buyers who can in reality meet the mortgage payments plus their living costs being declined by the bank because either they do not have a large enough deposit or according to the banks computer they do not earn enough.

With the rapid increase in property values over the last few years first home buyers need higher deposits and greater incomes, but incomes have not risen by anywhere near as much as house prices. Anyone who is 45ish or older would have purchased their first home when the ratio of the average income to purchase price was 3.5 times, now in Auckland its 9 times!

So how can the Bank of Mum and Dad help? What are the options?

Guarantor Parents can use the equity in their own home as a substitute for a lack of an adequate saved deposit by offering their house as security in addition to the property being purchased. The bank will take a mortgage over both properties. With the kids repaying both loans. Due to the requirements of the Responsible Lending Code banks will examine these arrangements very closely. A full application is also required from the parents. Signing on to be a guarantor is a big commitment, because if the borrower is unable to meet the repayments, the guarantor will become responsible for repaying the debt on the guaranteed portion—or the property that was offered as additional security could be sold to repay the debt. There are ways that the parent’s liability can be limited and the loan can be structured so that the guaranteed portion can be repaid first. Independent legal advice is always recommended. Parental Gift Parents can provide cash to help boost the deposit by gifting money, call it an early inheritance. A gift can seem like the most straightforward option, as it usually only requires a gifting certificate, is tax free and doesn’t have to be reported to the Inland Revenue. But it does rely on the parents having the money in the first place. Sometimes kids will elect to gift back the money at a future stage.

Deed or Acknowledgment of Debt This is basically a cash loan that is non-repayable, non-interest bearing and is only repaid on the sale of the house. A signed Deed of Debt will need to be completed. Often parents will use this to protect their money from future relationship break ups. In future years, the debt can be gifted away or once the property has risen in value and the kids are earning more this debt maybe able to be repaid and then recycled to other family members.

Parents buy a property to 'Rent' it Back to The Kids This is where the parents buy the house now, and “rent it back to the kids”. The kids assume all the advantages and obligations of owning a house, they pay the mortgage, insurance, rates, maintenance. They have security of ownership and can also do up the property if they wish. In 5 years, to get past the IRD “Bright Line Test” the kids buy the property back from the parents at the then market value. However, the parents will gift back any difference between the original purchase price and the current market value, thus, creating equity and locking in the capital gain for the kids.

There are a number of different variations and combinations of the above depending on the individual circumstances of the kids and parents. The trick is to get the borrowing below 80% and avoid the banks additional hurdles. While the whole idea is about getting the kids onto the property ladder any arrangement has be affordable in the long term for them. Also, as the parents are exposed to the additional finance risk, consideration has to be given to minimising this risk by having the correct level of insurance for the kids. As with any “family agreement” it is important that everyone involved is on the same page and are working towards a common goal. They need to consider what will happen if circumstances change or if one side needs to withdraw from the arrangement earlier than originally planned.

There are a lot of options, with pros and cons for each. If this is something that you are considering please feel free to contact me to discuss what will work best for your family situation. [if !supportLineBreakNewLine] [endif]