Insights

Introduction

Wealth transfer from the baby boomer generation has begun, with home ownership being a significant catalyst. The rising cost of homes in Australia, coupled with the steady target cash rate of 4.35%, has led many parents to consider helping their children buy homes. However, before stepping into the role of the ‘Bank of Mum & Dad’ it’s essential to evaluate the benefits, risks, and long-term implications on your financial security.

Understanding the Financial Landscape

The average price of a home around Australia (from highest-lowest) is:

• NSW: $1,184,500
• ACT: $948,000
• VIC: $895,000
• NT: $489,200

With the target cash rate expected to remain steady at a 12-year high of 4.35% in 2024, parents and family feel the pressure to help younger generations become homeowners.

Over the last 15 years, home ownership has fallen from 70% to 67% of the population. Declining home ownership will increase the wealth gap as home ownership is a significant factor in wealth accumulation.

The Actuaries Institute’s research has shown that wealth inequality is significantly higher now than in the 1980s, with the wealthiest 20% of households currently having six times the disposable income of the lowest 20%.

The Domain’s First Home Buyer Report 2024 estimates that a couple aged between 25 – 34 will need 6 years and 8 months to save a 20% deposit for an entry level home in Sydney. For Melbourne, the average if 5 years and 5 months and Australian average is 4 years and 9 months.

Many parents would choose to help their children buy a home rather than benefitting from an inheritance later in life. However, it’s essential that any support does not risk your financial security, meaning that you should only provide support that you can afford.

Before lending large sums of money, you should consider what happens if:

• There is a divorce or separation
• Your child remortgages the property
• There is a death
• The relationship becomes acrimonious

Providing Security to Lenders

You can use a family guarantee to support a loan in part or in full. With some lenders, you can use your security to contribute towards your child’s deposit to avoid lender’s mortgage insurance (ranging from 1-5% of the loan)

When you act as a guarantor for a loan, you provide equity, often in the form of cash or property as security. If your child defaults, you must cover the guaranteed amount. If you’ve secured the loan against your home and can’t repay it, the lender will sell your home. Review the impact on your finances before acting as a guarantor for your child. When you have more than a child, look at equalizing the impact of the assistance you provide in your estate.

Co-ownership

There are two potential structures for buying a property with your children:

• Joint tenants split the property evenly, and if you die, the property passes to the other owner(s) regardless of your will.
• Tenant-in-common – the more popular option as it allows for proportions other than 50:50 (i.e 70:30). If you die, your share is distributed according to your will.

If the property is mortgaged and the other party defaults on the loan, you may become responsible for the loan, regardless of the ownership structure. Consider this before entering into loan arrangements.

Reduced or Rent-Free Property

Buying a house and allowing your child to live in the house rent-free or at a reduced rent does not add value to your child’s ability to secure a loan or utilise the equity of the property to build their own wealth.

If you treat the property your child is living in as an investment property and claim a full deduction for expenses relating to the property, then rent needs to be paid at market rates. If the rent is below market rates, the ATO may deny or reduce deductions for losses and outgoings depending on the discount provided. Any rental income received is assessable to you. You will pay Capital Gains Tax on any gain when you sell the property or transfer ownership. If you intend to give the property to your child, ensure your will is properly documented to support this.

The Downside of Cash Gifts

A cash gift towards a deposit or mortgage is a simple and effective method of helping a family member. However, there are a few implications:

• Where the gift forms all or a significant portion of the deposit, lenders may want to ensure that the loan is serviceable and may require verification of the source of the funds to ensure that the amount is not a loan and does not require repayment.
• In the event of a divorce or separation, the gift may not overtly benefit your child, and instead form part of the property pool to be divided.

Gifts from a family member are not normally taxed.

The ‘Bank of Mum & Dad’

If you provide a loan to your child to purchase a home, document the terms, preferably by a lawyer.

There are many ways to structure the loan, for example:

• A loan with regular repayments
• Repayment when the property is sold or ownership changes
• Managed by your estate in the event of your death (treated as an asset of the estate, offset against the child’s share of the estate, or forgiven).

It is essential to have a written agreement in place that defines how co-ownership will work. Some scenarios to consider:

• If your circumstance changes and need to cash out
• What if your children want to sell and you do not?
• Will be property be valued at market value by an independent valuer if one party wants to buy the other one out?
• What happens in the event of death or dispute?

If you don’t live in the property as your primary residence, capital gains tax (CGT) will likely apply to any market value increase when you sell your share. You won’t benefit from the main residence exemption. Keep records of all related costs to maximize the CGT cost base and reduce any capital gain on disposal.

Utilising A Family Trust

Another complex option is to purchase a property in a family trust, where you or a related company acts as trustee. This strategy is often used for asset protection. You may pass control of the trust to your child without triggering major CGT or stamp duty liabilities. However, professional advice is necessary. When you sell the property, CGT will apply to any increase in its value. The main residence exemption can’t reduce your tax liability, even if your child lived in the home.

State tax issues

In some states, owning property through a trust means the tax-free land threshold won’t apply. This can lead to possible increases in land tax liability. In addition, if the trust has any foreign beneficiaries, this could potentially result in higher rates of stamp duty.