Options for parents to help
It’s every Kiwi’s dream to own their own quarter-acre share of paradise. Unfortunately for many young people today, not only are the quarter-acre sections fast disappearing into multi-complex developments, but it’s also becoming harder than ever before with an ever-rising property market.
Every time you turn on the news, we hear something about the housing unaffordability in Auckland. Those south of the Bombay Hills start to get a bit glassy-eyed when listening to this on repeat. However, since the government’s introduction of the ‘LVR’ rules in October 2016 aimed at improving affordability in these markets, we must pay attention as all of New Zealand is affected.
The LVR explained
The loan-to-value ratio (LVR) is a measure of how much a lender will lend against a mortgaged property compared with the value of that property. Borrowers with LVRs of more than 80% (that’s less than 20% deposit) are often stretching their financial resources. As well, they are more vulnerable to an economic or financial shock, such as a recession or an increase in interest rates.
The LVR rules permit lenders to make no more than 10% of their residential mortgage lending to high-LVR borrowers who are owner-occupiers.
The effect of this means that in order to buy your first home, you now must have a 20% deposit. In the Auckland and Queenstown markets where the average property price is over $1 million, this is a big savings hurdle for the buyers who want to take their first step onto the property ladder.
If you are financially able and willing to open your wallets to help, there are options to support your children who are struggling to meet the LVR requirements. Below, we outline some of the more common options available.
Most importantly, the decision to offer a helping hand needs to be informed and time needs to be taken for each party to obtain the appropriate legal advice. Depending on the option/s chosen, there may be significant paperwork to be prepared that records the complexities of the ownership and security arrangements.
This is not something that can be completed overnight. You should get the ownership structure agreed before anybody signs on the dotted line.
Option 1: Gifting some funds
In this option, your child acquires the property in their own name and a gift of equity of the shortfall of the 20% deposit is made from you to that child. Lenders typically want confirmation that the 20% deposit is the purchaser’s equity and therefore any financial assistance is generally required to be gifted. The gift would need to be documented by way of a deed of gift.
If a gift is made, there’s no ability for parents to later on demand partial or full repayment. This is an important consideration from both a relationship property perspective for your child and also for your own future financial needs.
You must be careful that your generosity towards your child does not get in the way of your own retirement planning.
If you want to protect the gift made for relationship property purposes (if your child is in a relationship), your child should enter into a contracting out agreement to record the gifted amount as their separate property.
Option 2: Loan from parents
If you can persuade the lender to agree to a loan to your child rather than a gift, then the shortfall of the deposit amount can be lent to your child. The terms of the loan would need to be recorded, generally, in a deed of acknowledgement of debt. This would include naming your child as borrower, interest to be payable (if any), dates for repayment, the ability for the loan to be transferred to a second or subsequent property and, most importantly, the ability to register a mortgage as security for the loan.
Option 3: Guarantee from parents
Under this option your child would purchase the property outright and any shortfall in the 20% deposit can be guaranteed by you as parents. The guarantee should be limited to the amount of the shortfall. The lender would also generally require that the guarantee is supported by a mortgage over your own property. If you choose this option, it’s important that all parties talk to the lender early on. As well, there would be a requirement for you and your child to each receive independent legal advice.
The benefit of a guarantee is that there is no money required upfront. There is, however, considerably more risk should your child default in their obligation to the lender.
Option 4: Joint purchase of property
If your child can’t afford to buy their own property, you could buy a share of that property. The title to the property would then have you and your child registered as tenants in common in the shares owned. This option provides some security and potential capital gain return for you as parents. With joint ownership, careful discussion still needs to be held with the lender regarding the required securities.
With this option, it’s essential that a property sharing agreement is entered into between all of the co-owners. This records the terms of the purchase, who will pay for outgoings, repairs and maintenance, management of the property, what happens if your child fails to perform their obligations and, most importantly, an exit strategy for you as parents. Again, you and your child will need independent legal advice.
Option 5: Family trusts
A family trust could be used in many of the ways explored above, if the terms of the trust deed allow this. Family trust funds could be used to distribute or lend money to a child beneficiary to help them buy a first home. Likewise, the trust could provide a guarantee or be a joint purchaser.
A trust, of which the child is a beneficiary, could also be used as the purchasing entity. Once again, specialised legal advice needs to be sought regarding the trust and structuring of any lending.
If your child is reliant on a government grant for part of their cash contribution, the property must be owned personally for the first six months. No family trust ownership is allowed.
Although trusts have historically been used to provide relationship property protection, this is no longer the case. Trusts can also be open to claims.
Whichever of the five options above you choose, you should also review the terms of your Wills or Memorandum of Wishes for your trust. As well, it’s important to ensure that any assistance, gift, loan or any potential liability under a guarantee or co-ownership arrangement is taken into account when dealing with all your children on an equal basis (if this is what you want to happen). This will help protect against claims by disgruntled siblings if similar assistance has not been provided to them.
Important to get advice
If you are financially able and willing to lend a hand to your child to help them into their first home, there are options to assist with meeting the criteria of the LVR rules. Our advice is to ensure you take control of the decision making and get expert legal advice on the options available to you before your child commits you to something that may not be the best option for you. Parents can provide valuable support but it must work for all involved.