The high cost of tapping the bank of mum and dad

Despite dire predictions of plummeting house prices and diminished home equity in 2020, after a brief and inconsequential decline, the property market has again taken off. This time however, it’s different.

Increases in property prices are not concentrated in state capitals as usual. One thing the COVID-19 pandemic taught us is that people can work from (just about) anywhere. As a result, the current property boom is more widespread, taking in regional towns as well as capital cities.

While rising prices are great for homeowners, it’s a hard slog for those trying to buy their first home. A higher price means a larger deposit is required; where that deposit doesn’t reach at least 20 per cent of the home’s value, buyers are usually up for expensive mortgage insurance.

It’s not so surprising then that would-be homeowners are tapping the Bank of Mum and Dad to help get onto the property ladder. So much so that, according to analysis by Digital Finance Analytics (DFA), the Bank of Mum and Dad has become Australia’s ninth largest mortgage lender, giving or lending their adult children an average of $89,000. This has increased approximately 20 per cent over the past 12-months.

DFA’s research suggests the Bank of Mum and Dad has approximately $34 billion in outstanding loans … a larger loan portfolio than some banks!

How do parents fund the Bank of Mum and Dad and what are the potential repercussions?

Funding the Bank of Mum and Dad

Traditionally, the Bank of Mum and Dad has relied on one of three strategies, each of which has its downsides.

  1. The first and most common strategy sees parents raiding their retirement savings or other nesteggs; this can, of course, negatively impact future retirement plans. It could mean you live on a reduced retirement income stream or see you with less capital to meet other needs during what may be twenty plus years of retirement.
  2. The second strategy is to be a mortgage co-borrower. While it might seem a reasonable idea to co-borrow, it means you’re liable for mortgage repayments if your child misses them. It’s also possible that your child may miss out on first home-buyer incentives offered by state and federal governments.
  3. The third strategy is to be a guarantor on the mortgage. This needs careful consideration; being guarantor can constrain your own ability to borrow and may put your property at risk if your child defaults on their mortgage repayments.

Using your home equity – what we like to call your Household Capital – removes these risks because the loan doesn’t have to be repaid until you leave your home, or it’s sold. When using home equity, you can agree a regular repayment schedule with your child, such as regular interest-only repayments or a future lump-sum repayment.

Can being the Bank of Mum and Dad affect pension entitlements?
Before you give your kids money toward a home, you must be clear on whether it’s a gift or a loan. If it’s a gift and you receive the Age Pension (or other benefits) you must declare it to Centrelink. The annual limit for gifting is $10,000 (or $30,000 over five years depending on your situation) – anything above that may affect your entitlements for up to five years.

If it’s a loan, it can still impact your pension entitlements. If you lend your children money instead of gifting it, that loan will be treated by Centrelink in the same way as most other investments, with a deemed rate of return – even if your kids weren’t expected to pay you interest or stop paying the interest you agreed.

Importantly, the impact of the loan on your Age Pension isn’t limited to five years, but for as long as the loan is outstanding. It’s advisable to speak to Centrelink, if applicable, before making any decisions, to ensure you understand the potential ramifications.

It’s also advisable to provide your kids (or grandkids) with a statutory declaration stating whether the money is a gift or a loan. If it is a loan, this should include the loan’s terms. Household Capital requires legal advice for all Household Loans; any terms agreed by you and the recipients should be documented as part of this process.

In matters of money, emotions can get the better of us. If you use a Household Loan to be the Bank of Mum and Dad, we want it to be right for you as well as the right thing to do by your kids. Being clear and upfront helps keep everyone secure.

To see how much home equity you could access, try our easy-to-use calculator.

Our Household Loan enables you to help your children when they need it most and use your home equity to help the next generation build theirs.

What are you doing with your Household Capital?

Applications for credit are subject to eligibility and lending criteria. Fees and charges are payable and terms and conditions apply (available upon request). Household Capital Pty Limited is a credit representative (512757) of Mortgage Direct Pty Limited ACN 075 721 434, Australian Credit Licence 391876.

Household Capital is a YourLifeChoices preferred partner.

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Written by Josh Funder

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