Helping your children buy their first home
Daniel Cowan, Partner
Current Reserve Bank lending restrictions mean that we are seeing a large number of parents being asked to assist their children to purchase their first home. While assistance may only consist of a small gift of funds from the parents, more and more we are seeing large guarantees being required from parents to cover a shortfall in deposit.
While many parents are not in a position to be able to gift funds to their children they may have sufficient equity in their own home. It may seem a much easier and cheaper option for parents to provide a guarantee using the parent’s equity in their home as security, however providing a guarantee comes with its own risks.
Normally if a purchaser has a shortfall of deposit, for example $30,000.00, the bank will require a guarantee for this amount (sometimes even a higher amount) plus interest, penalty interest, legal fees and any other costs of collecting the amount. Some of the risks/details that a guarantor needs to be aware of are:
- The guarantee remains the same even if the borrower’s equity in the property increases and/or there is a reduction in the amount owed;
- The release of the guarantee is entirely at the Bank’s discretion. This means that even if the borrower reduces their home loan by $30,000.00 (which was the original shortfall in deposit) the Bank is under no obligation to release the parent’s from their guarantee.
- The Bank is not required to seek the guarantor’s approval should the borrower wish to increase their borrowings;
- The Bank is not required to advise a guarantor should the borrower be in default of any arrangements;
- Even when the guarantor has been released by the Bank, in some circumstances, the Bank has the ability to reactivate the guarantee up to two years later; and
- In the event the borrower defaults, the Bank makes demand on the parents and the parents are unable to repay, the parent’s house may be sold by the Bank to cover the guaranteed amount. Costs of a mortgagee sale are significant and would have to be met by the parents.
Other options for assisting your children may be as follows:
1. Shared Ownership
This is where a parent owns a share of the property, in relation to the deposit provided, with their child. For example a parent provides 20% of the purchase price, in addition to any of the child’s deposit, and is recorded as owning a 20% share of the property. Both parties borrow the remainder with the parties entering into a Co-ownership Agreement (recommended) to agree on who is responsible for mortgage payments, maintenance, rates, house insurance and what happens when the home is sold. This is more of an investment option, especially for larger sums required, for parents who have cash available and is not suitable for all.
While again not feasible for all, parents can gift the required sum to their children to assist in the purchase of the house. The bank would normally require written confirmation that the funds are not to be repaid. This gift does limit the parent’s exposure should the worst happen to the amount of the gift as opposed to a guarantee where the parents exposure could be much greater. However gifting a deposit to a child in a relationship, with the funds being put into the family home, will mean that in the absence of a Contracting Out Agreement pursuant to the Property (Relationships) Act 1976 the gift will become relationship property.
3. Loan to the Children
A parent or a Family Trust can loan funds to a child for the deposit which should be documented. However some banks, depending on the individual situation of the borrower, will not permit these funds to be borrowed or may require that the loan is not repayable for a minimum period or only when the property is sold.
While initially a guarantee can be the cheapest, quickest and easiest way of assisting a child into a family home, it can have far reaching consequences. We strongly recommend that you consider other available options. If you decide to provide a guarantee you should ensure that, before finance has been confirmed for a purchase, you and the borrower understand the exact amount and the terms of the guarantee.
We also recommend that you investigate all potential options to assist your children by talking to your lawyer and your mortgage broker prior to any sale and purchase agreement being entered into.
The information contained in this paper is necessarily of a generalised nature and specific advice should be sought in relation to any particular situation. Further information and assistance in relation to this article can be gained by contacting senior commercial lawyer Daniel Cowan.