Banks are restricted by the amount of lending they are able to offer purchasers due to a Loan to Value Ratio (LVR) imposed upon them by the Reserve Bank.
The LVR is the amount of the loan divided by the value of the property and if this is more than 80%, i.e. there is less than a 20% deposit, the banks are stricter with the amount they will lend.
If there is less than a 20% deposit, we suggest talking with a banker before starting the process of looking for a property. In some situations a deposit of 10% is enough, although in our experience those with less than a 20% deposit are often charged extra fees and higher interest rates.
If the bank won't lend, it is better to know this before spending time and money signing up to purchase a property. If finance has been pre-approved, the amount that can be borrowed will be known before starting a house hunt.
More often, we are seeing family members assisting a buyer who is just under a 10% or 20% deposit. We will use the example of a young couple buying their first home. The parents of partner A want to help the couple into the property.
There are different options available to the parents to help their child:
The parents could make an outright gift. However, this may have implications for them. For example, if their circumstances changed and they needed to request a return of the funds they would be unable to do so as the funds have been 'gifted'. The parents would be relying on their child to reciprocate the goodwill.
Making a gift may also affect future applications for means tested benefits or rest home care. A gift can be considered a 'deprival of assets' and the Government agency dealing with the application has the discretion to 'claw back' the gift into the applicant's asset pool, meaning that the person would have to pay for their care until their assets were under the qualifying level for Government assistance.
Parents may not have cash to give to their child, but they may have equity in their home or other property which they are comfortable using as security for the couple's borrowing.
We always recommend that any guarantee is limited to the minimum figure possible. In addition, we suggest there is an understanding between the guarantors and borrowers that the guarantee is to be released as soon as the borrower can stand on their own feet, i.e. when the equity in the property reaches 20%, whether it is by way of loan repayments or revaluation.
A guarantor should be aware of the borrower's financial circumstances on an ongoing basis. There is no obligation on the bank to update the guarantor as to the borrower's repayments or debt levels so a guarantor needs to stay informed directly through the borrower.
There is no benefit to a guarantor; they expose themselves to liability for the borrower's benefit, often by way of offering equity in their home as security.
With the bank's consent, a parent's contribution towards a purchase can be lent to the family member. That loan will rank behind the bank in terms of repayment and security.
Most banks are receptive to a contribution to purchase, which is recorded as a loan, so long as repayment of the family loan cannot be demanded until the sale of the property and after the bank has been repaid in full. These terms ensure the bank knows that the loan can't be called up at any time, which, in so doing, would alter the borrower's LVR.
If a lender wanted to take a registered security interest in the property, a second mortgage over the property could be registered with the bank's consent.
Other considerations may apply to the parents' circumstances and their decision to help their child:
Parents may be happy to make a gift to a child but don't want to see those funds fall into relationship property realms where by a 'would have been in-law' walks away with half of the gift amount when the relationship breaks down.
A good option from a relationship property perspective is to make a 'repayable upon demand' loan to the couple. That way the loan can be called up if the relationship breaks down and the property is sold (likely after the bank has been repaid as per our comments above).
If a parent did gift to their child, a secondary layer of protection for that gift is if the child enters into a Relationship Property Agreement with their partner to record the gift as their separate property. Meaning that the gift amount would be payable to them in full should the relationship end.
Often a buyer with less than the required deposit will just want the purchase settled as cheaply as possible. However, due to the involvement of parents there are added transaction costs. Costs will vary depending on the circumstances.
The parties may want to complete a Contracting Out Agreement which defines each partner's separate property and documents how property is to be shared should the relationship end in the future. For this Agreement to be valid, each party needs to obtain independent legal advice which adds cost. It may seem like an expensive process, however, when the relationship ends and there is say a $50,000 family contribution at stake, the money spent to document that contribution as one partner's separate property is likely to be considered money well spent. It may be that those costs are met by the party providing the gift and can be included as part of the gift amount.
Parents may have the means to assist one child but know that it will set a precedent for their other children which they will struggle to meet. It may be that parents can assist their children in different ways, or that things are equalized as part of the parents' estate planning arrangements and are recorded in their wills.
Careful consideration needs to be given to estate planning in families and this process is better if it is started earlier.
Generally, our advice is for parents to loan funds to a child to get their deposit over the required threshold. That way they are able to call on the funds if they are needed in the future. However, as you will recognise there is no 'one size fits all' solution. If you are thinking of helping family members into a home or providing financial assistance, please contact one of the Wynn Williams private client team members to discuss.