Proceed with caution the Bank of Mum and Dad
Stepping in to help children enter the property market might be a noble thing to do. But it can come with a few risks
The great Australian dream of owning property has become a tall order for first-time homebuyers. And with the soaring cost of living, saving for a deposit isn’t getting any easier.
As a parent, you may be thinking about tapping into your savings or home equity or going guarantor to help your children secure a home loan. You’re not alone. Parental contribution is on the up, with parents contributing around $90,000 per child on average*, a 20% increase on the previous year. The ‘Bank of Mum and Dad’ has become Australia’s ninth biggest mortgage lender.
Like all financial decisions, there can be some risks and important considerations to weigh up before stepping in to help. And making sure you understand the impact on your finances and your future is key.
The question of affordability
Perhaps the most important consideration is whether your children can actually afford the property they want to buy. Going guarantor or contributing to a deposit may help them secure a home loan, but can they service the home loan with their existing income? No doubt, it could be a hard conversation to have, but a crucial one with the rising cost of living and interest rates increasing.
Getting things out in the open early can help to ease your mind and avoid issues down the track. Once you’re confident their finances stack up, you can weigh up your options with an increased sense of peace of mind.
The impact on your Age Pension entitlements
If you’re eligible for the Age Pension, it’s important to understand any implications gifting can have on your payments. Any money, income, or assets you have gifted in the past five years may count towards your assets and income test, unless it falls within Centrelink’s ‘allowable disposal amount’—the amount you can give without it affecting your payments. Whether you’re a single or couple, these limits are:
- $10,000 in any one financial year and
- $30,000 over five financial years.
Any excess above these limits will be included in your assets test, with deeming rates applied, and included in your income test.
Alternatively, you might consider loaning funds to your children. It’s important that you seek legal advice to document such an arrangement, and when it comes to the Age Pension, a loan to your children is treated like any other financial asset you own.
The longer-term impact on your retirement
Less immediate, but just as important, is the impact on your retirement savings. While your money is invested, it has the opportunity to grow and earn you money. Withdrawing money from your retirement savings can leave you with less to live on during retirement, and may even see you outliving your savings.
The risk of outliving your savings can become greater as you move closer towards retirement, as your money can have less time to recover from market falls. Most people aren’t aware that life expectancy increases as you age. Someone who is 65 in 2018-2020, will have a life expectancy of roughly 85 years (for a male) and roughly 88 years (for females)^. As you get older, your life expectancy increases again.
The risks of going guarantor
Aside from putting your hand in your pocket, there are other ways to step in and help out. For example, going guarantor on a home loan for your children could help them increase their borrowing power and avoid lenders mortgage insurance.
However, going guarantor on a home loan is a big deal. Essentially, it means that you are providing the additional security to guarantee that the lender will get their money back if your child can no longer afford their repayments and defaults on their loan.
In this scenario, as the guarantor it becomes your legal responsibility (for the portion that you guaranteed). This responsibility might include the principal amount, any interest and default interest, plus any fees incurred by the lender in resolving the default. If you don’t have the spare cash to meet your obligations, the lender may sell the asset that you put up as security to pay the outstanding debt.
There can be other potential financial impacts too. For example, any repayment you make towards the loan is considered a gift (which may affect your Age Pension), and the loan could affect your credit rating if it isn’t repaid on time. And if you’re hoping to take out a loan yourself in future, lenders may look less favourably on you if you’re a guarantor on another loan.
The impact on your relationship
Mixing family and finance can be risky, so it’s best to have some strategies up your sleeve to limit any potential damage to your relationship. One way to possibly avoid a family fallout is to be completely clear about whether you are gifting or loaning any money. Importantly, if you are loaning money, setting out your expectations about repayment can be crucial.
Things can become more complex when a child separates from a partner. To protect any money you are gifting or loaning, you could consider putting in place a legal document outlining who the money belongs to or when you expect it to be repaid. A legal document may seem overly formal, but it can be a good safety net if circumstances change.
Helping your children better their financial future can be an extremely satisfying thing to do as a parent. But it can come with risk. Doing your due diligence and leaving the lines of communication open can go a long way to keeping your family’s harmony and finances intact.
If you’re thinking about helping your children secure their first property, consider seeking qualified professional advice to discuss your options and whether this may be appropriate for you.
- Have an open conversation with your children about money
- Before loaning or gifting anything first check in on your super balance to see if your retirement savings are on track and if you can afford it
- Consider seeking professional advice before making a big financial decision.
*Digital Finance Analytics, as cited in the AFR, March 2022
^Australian Bureau of Statistics (ABS) Life tables, 2018-2022