How to help your children break into the market: Mark Armstrong
Auction clearance rates nudged 70% in Melbourne last weekend and now all the major banks have followed Westpac’s lead in dropping their two year fixed rate to 4.99%. The scene is set for the market to move – particularly the inner urban areas – and I believe it will grow by more than 10% this year.
For many people, this is a scary proposition, as getting into the market is already difficult. With four young children of my own at home, I often wonder how on earth they are going to be able to afford to get into the market. I am sure it will just be a matter of time before they stop asking for iPods and get into more serious requests.
Many parents are already being called upon to assist their children either into their first home or to upsize as they start a family. It is important, however, that both parties enter any arrangement with eyes wide open.
Let’s say your child wants to purchase a $500,000 property (a fairly modest price in many parts of Melbourne). Without a substantial deposit, they are forced to borrow 95 per cent of the purchase price, or $475,000. Unless they can find a way to reduce the loan amount to 80% of the purchase price, or $400,000, they will have to pay mortgage insurance. On a loan of $475,000, this could cost around $15,000.
To avoid mortgage insurance, they need a $100,000 deposit plus around $25,000 to cover stamp duty and other costs. They either need to save $125,000 or call in some help.
If you are willing and able to help, that’s great — but what’s the best way to do it, at a time in life when you are probably focused on saving for your retirement and can ill afford to risk your hard-earned savings?
Option One is to put the funds into a term deposit and offer that as security for the loan. This carries relatively little risk for you because it doesn’t make you responsible for paying back the loan.
In this scenario, they borrow 100% of the property value with a principal and interest loan in their own name. Over time, with the combined effects of loan repayments and capital growth, the loan balance will drop to 80% of the property’s current value.
They should keep an eye on sales results for similar properties in the local area, and ask a local estate agent to give an opinion on the property’s current market value. If it looks like the value has grown to the level where the loan is less than 80%, they can ask their lender or broker to arrange a new valuation. No need to pay for it as many banks now provide free upfront valuations.
If the valuation confirms that they have reached the 80% mark, the lender can release the term deposit and the money is yours again to do with as you choose.
What if you don’t have a lazy $125,000 in cash? Option Two is to take out a line of credit against your family home or investment property. You transfer them the funds, and they take out a $400,000 loan in their name. This option is relatively low risk for you because you are not responsible for the loan repayments. However, you need to understand that lenders charge interest on funds withdrawn from a line of credit. The rate is generally around .15% higher than a normal home loan.
Option Three carries more risk for you and should not be entered into lightly. Under this option you put up the family home or investment property as security for their loan. In this case, you become guarantors and therefore responsible for the loan. If they don’t meet the repayments, you could lose the property, though this only happens in extreme situations.
If you choose this option, it’s preferable to ask for a limited liability guarantee, which means you are not liable for the whole loan amount. In addition it is better, if possible, to use an investment property as security. This way, if the worst happens, the family home won’t be jeopardised.
No matter which option you choose, you should aim to minimise the level of risk and the length of time your funds are tied up. The sooner they can take full responsibility for their financial affairs, the better off everyone will be.
Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers
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The Mark at Sydney's Central Park
Previous experience shows that one month’s figures from one source are meaningless, particularly when there are numerous other research outlets with different figures.