Breaking Barriers with the Bank of Mum & Dad

The biggest challenge with property isn’t paying the mortgage, although that can be tough. Rather, it’s entering the market in the first place.

There are several tactics you can use to overcome that deposit hurdle, from securing government assistance and taking out a low-deposit loan to buying in tandem with another party and rentvesting in a cheaper market.

In recent years, another tactic has gained increasing prominence – tapping into the Bank of Mum & Dad.

Why the Bank of Mum & Dad has become so large

Unfortunately, it’s become increasingly hard for Australians to buy their first home, according to research from the Australian Housing and Urban Research Institute (AHURI).

“Home ownership rates at age 30 have fallen from a high of 65% among those born in the late 1950s to around 45% among those born in the 1980s. By age 50 there is incomplete catch-up in home ownership rates – which means that younger cohorts do not close the gap and catch up with their older counterparts. Around 25% of the home ownership gap remains,” according to the report.

Earlier generations have accumulated considerable wealth thanks to “rapid property price appreciation”. This has proved to be something of a double-edged sword. On the one hand, strong price growth has made it harder for younger Australians to enter the market; on the other hand, strong wealth accumulation has given older Australians the ability to help their children via the Bank of Mum & Dad.

“The Bank of Mum & Dad now represents an important source of funding for the transition into home ownership, with estimates suggesting parental support is among the top ten mortgage providers in Australia,” AHURI says.

How does the Bank of Mum & Dad work?

Assistance from the Bank of Mum & Dad can take three different forms:

• Allowing the child to live rent-free in the family home (to make it easier for them to save a deposit)
• Providing a cash payment (which could be a gift or loan) to cover some or all of the child’s deposit
• Guaranteeing the child’s mortgage, so they can qualify for a loan with a small deposit or even no deposit, without having to pay lender’s mortgage insurance (LMI)

Guarantor home loans explained

With a guarantor home loan, a third party – typically the borrower’s parents – will use the equity in their home to cover some or all of the deposit. Here’s a hypothetical example:

• Jane wants to buy a $1 million property, which means she needs to put down a $200,000 deposit to avoid paying LMI
• However, Jane has only $80,000 in savings, so she seeks assistance from the Bank of Mum & Dad
• Jane’s parents, Peter and Pamela, live in a house valued at $2.5 million that they own outright, and agree to guarantee their daughter’s home loan
• Peter and Pamela pledge their equity to cover all of Jane’s 20% deposit; Jane’s bank places a second mortgage on their home
• As a result, Jane doesn’t need to contribute any cash to the deposit, although she does use her savings to pay for the transaction costs (such as stamp duty and conveyancing)
• The bank lends Jane $1 million

Once Jane has built up 20% equity in her property, she can refinance to a ‘regular’ home loan, thereby removing her parents as guarantors.

While Bank of Mum & Dad assistance generally works well, it’s not without risk for the guarantors. That’s because Peter and Pamela are also liable for repaying the loan. So if Jane fails to make her mortgage repayments – and Peter and Pamela don’t cover for her –  the bank can seize Peter and Pamela’s home as a way of recouping its money.

Foreclosure is an extreme scenario, but one that’s theoretically possible with guarantor home loans, so it’s important for all parties to to have a full and frank discussion before proceeding. It’s also a good idea for the guarantors (Peter and Pamela in this scenario) to get legal advice.

Shore Financial can provide you with more detail about using the Bank of Mum & Dad and help you secure a guarantor home loan. To discuss your options, call us on 1300 416 700, email us on info@shorefinancial.com.au or fill in this online form.