Parenting

What first-home buyers should know about ‘bank of mum and dad’


If Australian parents were a bank, they would be the ninth largest home loan lender in the country – bigger than the Bank of Queensland and knocking on the door of Macquarie.

For many first-time buyers, a loan from their parents (the so-called “bank of mum and dad”) is crucial to gathering the money for a home deposit and getting approved for an eventual loan.

But on 1 July, as part of recommendations from the banking royal commission, the big banks will be imposing new rules on this type of lending.

Guardian Australia spoke to experts and the Australian Banking Authority to better understand the complex changes. Adult children can expect more rejections and lower approval amounts, while parents could end up in debt if the property market takes a turn.

What is the ‘bank of mum and dad’ and how common is it?

According to latest statistics from Digital Finance Analytics, 20% of first-home buyers rely on some kind of loan from their parents when applying for a mortgage. The average size of that parental contribution is $70,000.

And that used to be even more common. In June 2018, 60% of new buyers were borrowing money from their parents.

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In total, parents have lent a total of $30bn to their children as of April 2019. That’s more than HSBC or Citigroup.

Of course, every family is different, and some parents will charge interest, some won’t, and some are gifts. But the mortgage market is highly leveraged, creating risk for both parents and children if payments fall behind or house prices drop.

The average age of borrowers is 31 and the average age of parental lenders is 56.

Does that make me a guarantor?

There many ways parents help their kids financially – and they shouldn’t be confused with each other.

Sally Tindall, the research director of finance site Rate City, says there are three main ways: a parent becomes a guarantor to the loan, becomes a co-borrower, or gives their kids a cash gift.

“While the guarantor is not required to make regular monthly mortgage repayments, if their child defaults on the loan, the lender could ask them to step up and make the repayments,” she says.

It can also be a gift. But Tindall says banks will ask borrowers for a letter from their parents that clearly says it is a gift, and not a loan. Otherwise, they would have to factor that into their decisions.

What are the changes?

From 1 July, all major banks will have to adopt the new banking code of practice.

Essentially, if a lot of your deposit is being provided by your parents, banks will now be more thorough in trying to figure out if you have good savings habits yourself.

“Basically they will ask more questions about it – and I suspect they will be less generous if you got the money from mum and dad,” says Martin North of Digital Finance Analytics.

“It’s more forensic than it used to be. They didn’t ask previously. They didn’t really care. But now they will.”

“They may well ask for more bank statements, to see your expenses and to see if there is a history of saving. Many banks are asking for a breakdown into expense categories to make an assessment of how much free money a person really has.”

There will also be additional safeguards at the loan agreement stage. If the parents are guarantors, they will be warned about the risks of underwriting their children’s loans.

All guarantors will be given a three-day cooling-off period before signing contracts so they can think about it and get legal advice instead of being pressured in the moment to back a loan for a loved one.

“Becoming a guarantor for a loan can be a good way to help a child or close relative buy a house or start their own business. However, it is a serious financial commitment which should be carefully assessed,” said the ABA.

If I’m borrowing from my parents, what should I do?

Prepare for more questions, prepare for a lower loan approval – and start saving.

“You should still be really, really cautious about their ability to repay the mortgage,” says North. “You’re twice as likely to default in the first five years if you got help from mum and dad and never got into the savings mindset.

“You need to have evidence of savings experience. Suddenly seeing money coming in from your parents might not be taken that positively by the banks. They might still give you money, but they might give you less.”

He also stresses that parents and children should get their agreements clear.

“It’s very important for the parents and the kids to have their agreement documented. Is it free? Is it a gift? What is the interest rate?” he says.

“What happens if things change – if the parents divorce or separate? What happens if they default, what happens if your kid divorces their partner – or something else goes wrong?”

Borrowers should also be conscious of whether their parents can afford the loan – especially if they have a mortgage of their own.

“It’s great if you are one of those kids who has wealthy parents, but if your parents aren’t wealthy, there are risks on both side of the equation. For the parent and the child.”

Tindall says that the borrowers should also look at their own budgets before splurging.

Having a guarantor can allow you to “borrow without a decent deposit saved up”, she says. “While this might feel like a winning lottery ticket, it’s important for you to sit down and make sure you are comfortable getting in to that level of debt.

“Don’t rely on your bank to tell you how much you can afford to repay. Do the sums yourself and make sure you can meet the repayments comfortably, even when you factor in things like rising mortgage rates, the arrival of a new baby or a change in your job situation.”

If I’m a parent lending to my children, what should I do?

“Think twice,” says North. Especially if you are drawing on your own mortgage to lend to your kids.

“If you are a parent and you are basically pulling equity out of your property, you need to think very seriously of the implications of that down the track. Can you really afford it into retirement? What if house prices don’t go up enough to see you into retirement?

“A lot of people are relying on the value of their property to pay off the mortgage. If property prices don’t rise, you are in a conundrum.”

Tindall adds: “Parents might instinctively be willing to do whatever it takes to make their child happy, but entering into a guarantor arrangement should never be taken lightly.

“Before signing the paperwork, take some time to think about how things would play out if your child can’t pay the mortgage.”

And again, document the exact terms.

“You can sometimes be a bit too generous and make it too easy for your kid,” says North. “If they haven’t learned the business of saving, that is a problem.”

“If you have two or three kids, you have to think about equality across the kids. If you have three, can you afford to do it three times? Do you give them all the same? It gets quite complicated.”

What effect will this have on the housing market?

North thinks the crackdown on the bank of mum and dad will help keep house prices low – or at least not as high as its peak.

According to DFA’s analysis, the vast majority of parental loans are on the east coast – in Sydney, Canberra and Melbourne – where the property rise has been strongest and young buyers are more in need of help.

“I think we’ve definitely had the bank of mum and dad supporting the growth in house prices over the past couple of years,” North says. “My view is that because the bank of Mum and Dad is less active, that will be a future negative force on prices.

“My modelling suggests there might be a small recovery from the falls we are seeing now, as the rate cuts and APRA’s loosening of lending come through. But nothing fundamental will change – we are not going to see home prices escalating quickly.”

However, he says there are probably other kinds of incentives to help first-home buyers coming up – in addition to the election announcement of 5% deposits – such as further rate cuts.

“The Reserve Bank, the treasurer – all want people to spend to buy property to support the failing economy. There is a huge incentive, from a policy perspective, to get first-time buyers to buy at the moment. I wouldn’t be surprised to see more incentives coming down the track to drag people into the market.“

And the prospect of a weak housing market is what should make parents more cautious about lending to their children for housing.

“I think it is unlikely to see strong house price growth in the next decade,” North says. “The boom may not happen again. People should not necessarily expect the magic money machine to be around much longer.”

“Previously, it was because the house price rises were so strong in the east, and parents thought their kids could never get into the market, they wanted to help their kids.

“But now it begs the question – is the Australian fixation to get into the market a smart option in the current environment?”



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