Bank of mum and dad: Some pros and cons

Housing affordability, rather the lack of it, doesn’t seem to be going away anytime soon, and Treasurer Scott Morrison’s recent speech at an Urban Development Institute of Australia event just reinforced the view.  

In such a scenario, the ‘bank of mum and dad’ for first-home buyers might be the way to realise the ‘great Australian dream’.

With the apartment median price in Sydney around $850,000, and Melbourne not too far behind, saving for even that 10 percent or higher deposit is a tough task for the new kids on the property block.

Normally, when a borrower can’t meet a 20 percent deposit and stamp duty, the bank will impose a Lenders Mortgage Insurance, which adds up to a few thousands of dollars. 

The ‘bank of mum and dad’ can seem to be a good option in such circumstances.

Ask a parent how far they would go to support the financial aspirations of their children, and chances are they will say: “Yes, if I had the money I would be happy to act as a guarantor for my children to purchase a property.” 

According to Todd Hunter, founder and director wHeregroup, mum and dad can help their children — even when they are teenagers — get a head start into the property market by buying a cheap property in the right location and let it sit there for 10 or 20 years and grow in value. Once the property is sold, the children will have a ready-made deposit without asking parents for help.  

Cheap properties below $250,000, and they don’t have to be in the city. And cheap properties because they “tend to pay for themselves, meaning the rent pays the interest on the loan, so any extra payments they make go directly off the principal of the loan”.

While this may be a great way to get the next generation started in property, there’s also a rising trend for adult children who are already property owners to dip into the bank of mum and dad besides the first-home buyers, according to Mortgage and Finance Association of Australia (MFAA) director and managing director of smart lending Melissa Gielnik in an article in www.domain.com.au earlier this year.

“In the past three years brokers across the MFAA network have witnessed a spike in requests for these types of loans and expect this trend to continue. Parental guarantee loans represent over 15 per cent of loans written for some brokers,” Gielnik said.

“As the housing market continues to grow parental guarantees are becoming more popular with upgraders allowing them to avoid mortgage insurance and therefore borrow a larger amount,” she said.

Housing is the single biggest asset class in Australia, worth an estimated $6.5 trillion across 9.6 million dwellings, according to CoreLogic. To put it in perspective, this is worth more than three times the value of Australian superannuation funds ($2 trillion) and more than four times the value of Australian listed stocks ($1.5 trillion).

But roping in parents to guarantee loan doesn’t come without risks, as Mamiza Haq, a lecturer in finance at The University of Queensland, points out in an article in The Conversation. 

The risk to lenders

Family-pledged loans can be categorised as non-conforming loans, an area where lenders seek to minimise the level of risk as much as possible. The Australian Prudential Regulatory Authority has outlined some guidelines for Authorised Deposit-Taking Institutions (ADIs) with regard to loans including a guarantor relationship (e.g. from a parent of the borrower) as these loans carry a greater risk. 

Inadequate bank supervision and poorly underwritten home mortgages led to the financial crisis, adds Haq. 

Sydney mortgage broker Elaine Lam explains in an article in The Australian that while “a family guarantee can be a useful tool that allows borrowers to finance property with little or no deposit, the procedure can be a risky strategy as it allows borrowers to buy property with no cash and no evidence of genuine savings, as long as the bank is satisfied the borrower can meet the ongoing loan repayments, says Lam. In the event the borrower defaults on the loan, the bank will come after the parents for any losses and costs that the bank incurs.

Consumer advocates also cite “lots of cases" where guarantors have been faced with the prospect of losing their home, adds Haq.

In the current uncertain economic climate with low wage growth and rising costs of living, parents must consider the risks of acting as guarantor, and all the legal responsibilities that come with it, before pitching in to help your children realise the ‘Australian dream’.