Every parent wants to be able to help their children. More often than not, getting started in the property market is one of the most difficult financial goals the younger generation has. So it makes sense that you want to support your kids to reach this important goal. But how?
It’s traditional to receive ‘inheritance’, or some kind of financial boost from your parents upon reaching a particular age. But for many, being able to give a significant financial gift is simply not an option. We aren’t made of money, and with the cost of living going up and up, it’s becoming more and more difficult for an even larger amount of people.
So how then can you help the younger generation reach their financial goal of purchasing their first home?
The family pledge allows parents to use the existing equity from their home to provide extra security to a lender when providing a home or investment loan to a first home buyer. The family pledge can solve the main problem for most first home buyers, saving the initial deposit, as the extra security can take its place. Put simply, the family pledge uses equity of a home to reduce the need for a large deposit, and the time taken to save it.
The ability to work around the deposit can save a first home buyer countless years when saving for a home. Imagine getting into the property market in Sydney a few years ago before prices soared! The price of a home bought before the property boom could have jumped from $600,000 to $750,000. Imagine that instead of utilizing the family pledge, you waited and kept saving the typical deposit amount the banks demand. Not only would you have missed out on the $150,000 of growth, but you’d now be required to save a larger deposit for the same property before the boom! If the deposit goal was 10%, the goal post moved from $60,000 to $75,000, equating to many more months of saving.
So let’s give an example. You want to purchase a home at the value of $600,000. On a home of that value, there are associated costs (stamp duty, conveyancing fees, bank cost, inspection reports, etc) of $27,000. So $627,000 is what you need to purchase the property.
If the bank would lend you $570,000 (95% of the $600,000 value) you would need a $57,000 deposit. Unfortunately, there is one more cost to consider. When a loan to value ratio exceeds 80%, a lenders mortgage insurance cost is incurred. The LMI cost would be $22,600 in this example, therefore increasing the deposit requirement to $79,600.
$79,600 is a significant amount of money, and $22,600 is an excessive cost to pay for insurance that protects the bank, not you! This is where the Family Pledge kicks in.
On the same home, let’s say that the purchaser in question has saved $30,000. By using the family pledge, $600,000 can be borrowed, by allowing the bank to secure $480,000 against the property being bought, and $120,000 against mum and dads property. This saves $22,600 in LMI costs and all of the time that would be needed to save up the additional $27,000 which would have otherwise be required.
So there are serious savings for first home buyers to be made using the family pledge system. But what are the costs to the parents going through this process?
The parent offers a limited guarantee when entering a family pledge. This guarantee is limited to the amount of loan secured by the parents home.
Going back to the example we had before, a family pledge of $120,000 on a $600,000 home. If the borrower (first home buyers) defaults for whatever reason, and has not paid off enough of the loan so that the sale of their property can pay out the balance, then the guarantor is responsible to pick up the remaining value of the loan, up to $120,000.
And that’s it, the family pledge wrapped up!
If you want to discuss your options for setting up a family pledge, be sure to get in touch!
CEO McCarthy Group