Getting into your first home can be a tough milestone to achieve for today's Millennials and Gen Zs. House prices are up compared to past decades, particularly in heavily populated areas. In fact, according to a recent Barfoot & Thompson report, house prices in Auckland alone have skyrocketed over the past 25 years, from an average sale of around $253,000 back in 1996, compared to a median sale price of $910,000 in June, 2020.
To make market entry even more difficult, the cost of living in New Zealand has also increased. Since the very first year the Living Wage rate for New Zealand was established in 2014 at $18.40 per hour, the rising cost of living has pushed the threshold to a rate of $22.10 per hour in 2020.
As a result, young adults are struggling to set themselves and their families up for the future, and more and more kiwi parents are willing to give them a leg up by getting together money to help them into their first home - and it works too. Banks are open to accepting gifts, guarantors, borrowing against equity and family loans as a part of young kiwi’s mortgage applications. With that said, there are some key differences to understand when it comes to knowing your options for helping your kids into their first home.
Option One: The Out and Out Gift
This is the most simple and favoured option that banks prefer to see in home loan applications. The out and out gift consists of parents giving their child a lump sum of money towards a house deposit with no strings attached. There are no expectations of repayment, no claims to the asset purchased and no liability on the parents part should mortgage repayments fail.
Often a condition of a gift as a part of a loan application, is a certification or a letter outlining the terms and conditions of the gift. This has a dual function of guaranteeing the bank that no repayments from the recipient need to be made (therefore not affecting their loan servicing ability) and secondly, putting clearly in writing that the lump sum of money is in fact a gift.
As advised by the NZ Law Association, the option of gifting money can “add a layer of complexity to property ownership that, if not clearly agreed and recorded in writing, can cause problems later on”.
On the odd occasion, banks might also add a request for the verification of a deposit being made into the loan borrower's bank account as a condition of approval. However for the most part, a letter of agreement submitted in the pre-approval stages is sufficient.
Option Two: The Deed of Acknowledgement of Debt
This is a good alternative to offering an out and out gift if you’d like to be repaid eventually but are satisfied to lend a sum of money towards a house deposit in the meantime. In this instance, funds are given between parties, a contract is drawn up outlining terms of repayment and similarly to the ‘out and out gift’ option, the lending party (the parents) aren’t responsible as a guarantor for the servicing of the home loan.
A common clause that we see in this structure, is for parents to accept repayment upon the sale of the house. Banks find this favourable as there are no regular repayments required from the borrower (the child) and in most cases if the borrower holds the property for a number of years their equity will build and the original investment can be repaid in capital gains.
Interestingly, this form of loan is not technically considered ‘debt’ in the eyes of the banks, as the borrower is not contractually obligated to repay with any frequency.
Option Three: The Loan from Mum & Dad
The loan from Mum and Dad is an option that was popularised a decade or so ago when parents had enough untied capital to lend their children money to put towards a house, on the condition that they made repayments at a rate and frequency specified by their parents. In the past, interest rates have been comparatively high. This meant that loans from parents with no or low interest rates were a preferable option to lessen the burden of a full bank loan.
Although interest rates are now significantly lower, this is an option that’s still quite popular as it works in the favour of both the lender (the parents), the borrower (the children), which can work with the banks.
For example, the parents are able to recoup their investment over time, lessening the financial commitment of offering a lump sum of money. From the child's perspective, they’re able to put down a more substantial deposit and pay less interest over time. Finally, banks have the security of a higher deposit and are required to loan out less, sharing some of the risk of money owed with the parental party.
In any instance, banks require the terms and conditions of the parental loan to be written and agreed to in a contract to prevent conflicts and lessen the risk of non-repayment down the track. This way, banks have a guaranteed repayment figure that they can include in their assessment calculations to find out whether the borrower can service the loan. The borrower must be able to prove that they can afford to take out the loan in the repayment calculation stage, in order to have a successful application.
Option Four: Borrowing Against Equity
Borrowing against the equity a parent has built over time in property is a good option for borrowers who are strong in servicing (have a high income with low expenses) but have a smaller deposit saved.
For a lot of parents, they’re unable to lend their children a lump sum of money as their funds are tied up in their investments. This option allows them to give their children a ‘leg up’ by borrowing against the equity they have built in their property, without having to withdraw any cash.
For example, if a child needs to borrow a 600k loan but can only borrow $500k against their own property due to LVR restrictions, They then borrow the additional $100k secured against the property being offered by the parents. In this case the parents become liable for the extra 100k debt as it is secured against their asset. Therefore, the parents will be tested in terms of serviceability, as well as the child. This can often fall through when the parents are “asset rich” but unfortunately do not have the ability to meet the servicing/income criteria required to unlock the equity.
When Things get Messy
The key thing to note is that banks are conscious of entering any deal with multiple parties when agreements aren’t clearly defined and it’s probably that things could get messy.
For example, if parents want to have an interest noted on the title of the property in in exchange for their investment in the property. If the property ever was to be resold or go to a mortgagee sale as a result of nonpayment, the process would be risky and problematic for the banks.
For this reason, banks prefer agreements, whether it’s a gift, loan, borrowing against equity or otherwise, to be made separate from property titles. We’d always recommend getting your agreement put in writing, and being as clear as possible about entitlements, repayments, expectations and even circumstantial sales before accepting family support.
Want advice on how best to help out your kids?
If you’re considering helping your kids out to get into their first home, but aren’t entirely sure what options are available to you, we can help. Get in touch with one of our experienced advisers for a chat. Even if it’s just to clear up definitions of terms or go through your potential options, we’re happy to help.