To put it bluntly, Baby Boomers need to help their kids get into the property market. Without that help the maths doesn’t work and they will not be able to do it. It’s as simple as that.
This is largely a tale of 3 immigrant cities, Sydney, Melbourne and Brisbane that now have average prices that are outside the reach of a younger generation (although Brisbane remains the most affordable).
Let’s look at 1975 and see how the maths has changed. 1975 is a good year to pick because Baby Boomers were just turning 30, getting married, having kids and buying homes (on average they were marrying about 6 years earlier than they are today).
The average price of a house in Sydney was $34,000 (for a unit it was $26,000). The average income was about $8,000. So, very importantly the house to income multiple was in the low 4s (so 4 years income paid for a house, and less for an apartment).
Today the average house price in Sydney is $1m with average income about $75,000. So the multiple is in the low 13s (even with two incomes you do not get back to the maths of the 1970s). Put simply, the maths has changed so much that without some help younger generations will not be able to step onto the inflationary elevator that is Australian property.
While we are on the subject, I cannot help but talk about the cost of university. In 1974, just as a large wave of Baby Boomers were entering university, university fees were abolished and then in 1989 just as the last Baby Boomers were leaving university, the fees were reintroduced again. So today’s university student can easily leave university with a $30,000 debt (or much more) compared to the unencumbered Baby Boomer.
This is no insignificant matter and is very relevant to the discussion of entering the property market as these debts have a material impact of someone’s ability to get and service a loan. Having to pay 4-8% of your gross income with after tax dollars materially affects borrowing capacity and cashflow and delays the entry into the property market. It now takes on average about 8 years to pay off a university debt!
So that’s the back story, and now onto the question of what older, wealthier parents can do about it if they would like to help their kids in a material way.
1. Just give them the money
Let’s not beat around the bush. If you want to help them and you have the means to do so, just give them the money. Call it what you want, a gift or early inheritance, but the bottom line is that it was your money and you made it theirs. Saving enough money for a deposit nowadays borders on the impossible. After tax, living expenses and rent and the university debt there is not much left to save for a deposit that can easily reach $100,000. By the time they have been able to save the deposit, many years later, property prices have risen again and they never get to latch on.
If we put family relationships and politics aside, it really is a question of maths. Can you give them enough money to help them into the market without affecting your lifestyle? Even better, are you happy to have your lifestyle affected a little bit to help them in?
You can ask yourself The 5% Question…
2. The 5% Question
Would giving them 5% of your net worth affect your lifestyle today? If your net worth was $3m, would giving then $150,000 affect you and if so how much? If your net worth was $2m, would $100,000 affect you and so on.
Or, you might say, that a large part of your net worth is in your home and illiquid, so then you could ask the question a different way. Would giving 5% of your retirement fund affect you? So let’s say that between your super and an investment property you have $1.5m, would giving them $75,000 (or possibly less than one year’s returns) affect you?
I think you get the gist of the question. Whatever the amount or percentage is, what you are really asking yourself is whether you can do without that money in order to help a child into the market. One client comes to mind, who retired last year, with a net worth of about $4m. He gave his 28 year old son $200,000 to help him and his wife buy an apartment near the city for about $800,000. It hasn’t affected his retirement income in any material way and he is deeply satisfied with the fact he was able to get his son into the market. Now had he had 5 kids, his ability to help to that degree would have changed, but you have to work with the hand you are dealt.
I often hear concerns from parents around the loss of family wealth in the event of an adult child divorcing. It’s a legitimate concern but one that has solutions if you get the right advice.
3. Lend them the money
Alternatively you can lend them the money. This can take a variety of shapes and forms:
• These can be interest free loans, as they often are
• They can be an informal handshake agreement or they can be formalised with a written agreement
• They can have an indefinite repayment term, which makes them a gift by another name of an agreed repayment timeline
• They can be directly between you and your child or you can include a third party between you to formalise the arrangement
If you lend them the money on an interest free basis, you are in effect “gifting” them the interest on the money.
4. P2C La Trobe
La Trobe have created a formalised process that can be used to lend money to your kids (P2C or Parent to Child loan product). In effect you are inserting a middle man to help with the formalities. It is like letting your kids live in your investment property and pay rent, but getting them to deal with a local agent instead of you directly. More formal and potentially less family hassles.
It comes at a price but can certainly have its benefits. It can be a good tool to help the kids save on mortgage insurance (LMI) buy lending them enough (via a second mortgage) to get them to an 80% loan, which means no LMI.
5. HECS-HELP
You could choose to pay for their university education so that they leave university unencumbered. Or if they have a HECS-Help loan, you could choose to pay it off for them, which at the very least will help with any loan applications that they make. It will increase their borrowing capacity and increase their ability to cashflow any loans.
If they are paying say 6% of the gross income towards their student loan that could easily reduce their borrowing capacity by 20%.
6. Parental Equity and Cross Collateralisation
Cross Collateralisation is a mouthful, but in English it means using the equity in your home to support a loan that your kids could use to buy a property. So it is not a gift or a loan, but really a guarantee or a promise that if your child doesn’t pay back the loan, you will take ultimate responsibility. You are “giving” them your financial firepower or credit.
So let’s imagine that you have a $1m unencumbered home and your son, who has no deposit but a good income wants to buy his first home for $600,000. If the two assets are “Crossed” your son would be able to get the loan.
7. Family Pledge and limited guarantees
Another way of using the equity in your home to help the kids is by providing a limited guarantee or what is being called a family pledge. So, your child may need say $60,000 to get them over the line and especially if that number was required to avoid the cost of mortgage insurance. Well, a family pledge, secured via mortgage (including a second mortgage) against the home which has ample equity in it, might just do the job.
It may only need to be temporary because if the value of the properties rise, then you can have them revalued and if the new loan to value ratios are adequate, have the pledge released.
8. Joint Borrower
You could choose to jointly buy a property with them. It could be 50/50 or 60/40 or whatever percentage that works for your situation. You are on title and you are jointly responsible for the loan.
Them owning 50% of something is better than owning 100% of nothing.
You obviously are taking on the risk of the loan if your child fails to keep their end of the bargain, but there are varying degrees of risk within all these ideas and there is an assumed level of trust and reliability between parents and children for any of these strategies to work.
9. Early Inheritance
We have talked about this already, but it’s important to think a bit deeper about inheritance while we are on the subject. If you are 60 and your daughter is 35, helping her now with only some of your wealth could make a profound difference to her and a minor difference to you. But, if you go down the more traditional road of inheritance and give it all to her at your death, she could be waiting another 30 years and by the time she inherits the funds at 65, it doesn’t have the same impact on her life because she has lived most of it already.
So the whole idea of early inheritance is giving them the funds when it really matters.
10. High LVR (95%) Loans
Once upon a time these loans didn’t exist, but today because of people’s inability to save up large deposits and high property prices, they are a necessity for many first home buyers. The point here is that helping them get into the market may cost you less than you think.
Let’s say we are talking about a $700,000 property (especially in Sydney or Melbourne), 10% or $70,000 might do the trick. 5% for the deposit and another 5% for costs, mainly stamp duty. If that is all you can do, that might be just enough for them. They will still need to contend with mortgage insurance and servicing a large loan, but if they (and you) want to get into the market, it’s another way of doing just that.
11. Helping them get Government Help
Unfortunately Government support has been skewed towards new properties only, but it’s still better than nothing for some. The First Home Owner Grant, which has just been reduced to $10,000 in NSW (it was $15,000 last year) is available if your first property is a new one. Not ideal, but certainly better than nothing.
So, you could choose to help the kids buy a new property to access the grant.
There is also the First Home – New Home Scheme (again biased towards new property only) where the stamp duty is waived or reduced for properties up to $650,000 (in NSW). This can be quite significant as the stamp duty on a $550,000 property in NSW is about $20,000.
You can find out more on this in our eBook: First Home Buyers Guide NSW–QLD-VIC
12. Cashflow Contribution
Instead of a capital contribution, you could choose to help with cashflow and assist with the mortgage repayments (or part thereof) until their income reaches a point where they can comfortably pay the mortgage. I can hear you think, how did the bank lend them the money if they are struggling to pay it back? Well, it happens more than you think, people over extend themselves all the time and are able to find a bank that lends them more than they really should be borrowing.
13. Offset Accounts
If you have the funds and your son has a mortgage, you could get them to set up an offset account so that you could simply “park” your money in their offset account and save them the interest on that part of the loan. The only cost to you would be the “opportunity cost” of earning a return on that money in your own bank account.
If you had the money in your bank account you might earn 2% that you would pay tax on but in your daughters offset account she would save 5% on her debt, after tax.
14. Helping them to compromise
Too many people are struggling to make concessions to get into the market. If you have grown up in your parents’ home, near the city, near amenity, near the beaches etc. you might be finding it hard to make the necessary concessions to moving out and being an hour away from work. But that is the journey many will need to take if they want to get into the market. If a $1m property is simply not within your reach (with or without parents support) then you have to go looking at suburbs or property types that fit you (and your parents) budgets.
Parents may need to make their support conditional on some compromise.
The journey may begin in an area that is “less than ideal” but you can then work your way up the ladder over time and get closer to the city or work and lifestyle.
15. Renting & Investing
For a variety of reasons your children may not want to buy a property to live in. Maybe they want to live close to you so you can stay in touch with the grandkids (and do the babysitting!) or they want the flexibility of being able move around with work or as their needs change.
Financially, renting and NOT investing is a problem in an environment where asset prices keep rising. But renting AND investing is a perfectly legitimate wealth creation strategy for many and compares favourably with more traditional home ownership.
So, helping them buy an investment property can be just as profound a step in the long run to their financial well-being.
We have written much more in depth about the subject in our eBook: Renting vs Buying – Which is better in the long run?
Conclusion
As you can see, there are a variety of ways of doing this. What it really comes down to beyond capacity, is intent. Where there is a will, there is a way.
Making any or a combination of these ideas work for you requires customisation to your individual circumstances. There will be tax, legal and liability considerations for many of them and you would be well advised to first canvass the viability of an idea with a financial adviser.
They are best suited to navigate you through the varied and interconnected areas of expertise that are required to solve this type of problem.
