A lot of my clients tell me, “I want to help my children buy a home”. This is understandable given the average house price as a ratio to average income is the highest it has been in half a century (see graph below). However, when does helping your children become detrimental to your own retirement plans? Answer: Almost in every case because most people are doing it the wrong way.
Two-thirds of Australian households own or partly own their home. The average wealth of owner-occupier households with a mortgage is around $857,900 and for owner-occupiers who own their home outright, it is around $1.4 million, according to the ABS. The average superannuation balance for Australians aged between 45 to 54 is $151,500 for males and $90,800 for females. Australians aged between 55 to 64 have an average balance of $322,000 for males and $180,000 for females.
Most people who typically help their children to buy a home will do so by making a cash contribution towards a property deposit. This reduces their assets outside of the family home, thus reducing their capacity to earn a retirement income. Meanwhile, equity in the home remains untouched.
There are three ways you can help your children without having a detrimental impact on your own retirement plans:
1) Rather than giving cash, you may be able to use the equity in your home to be guarantor for a home loan your children take out with a bank. In many instances, this may remove the need for your children to pay lenders mortgage insurance. This can save approximately 1 to 2 per cent of the home purchase cost. But this does mean your home is used as security for their lending as well. Thus, you need to be confident that your children will be reliable in making all their loan repayments on time to the bank.
2) Loan money to your children rather than give it. If you do have some surplus cash earning less than 3 per cent, you can make an arrangement with your children where they pay you interest at a rate above what you would earn from the bank and below what they would pay to a bank.
For example, a $60,000 interest only loan given to a child at an interest rate of 4 per cent will provide $2,400 of income compared to $1,620 if the cash is invested in a high interest cash account with an interest rate of 2.70 per cent. Principle and interest loan repayments will amount to $3,800 per annum, of which $2,374 will be an interest component/income for you. However, if your child were to borrow $60,000 from the bank at a standard variable home loan rate of 5 per cent, they would be paying $4,209. This is nice little win-win scenario for both parents and children.
3) Accept your children may do things differently to you when you started out. What does this mean? It may be more efficient for your children to continue renting where they live and purchase an investment property. The tax deductions and rent can be less than them paying a principle and interest home loan. Thus, they can balance living where the want to live for lifestyle while still having an exposure to property as an investment.
For example, buying a $600,000 home today with an interest rate of 4.5 per cent will result in principle and interest loan repayments of around $610 each week. However, if your children wish to continue living in that trendy inner city suburb, next to all those funky bars and cafés, they will be paying upwards of $900 per week on that $850,000 to $1 million shoebox sized unit. The weekly rent is $600 for the same unit. If they use their cash savings (or loan from you, the parents) to purchase an investment property of the same value, their weekly holding costs after tax deductions and depreciation is as little as $20 per week. Thus, they can live where they desire and be close to work but still have a great asset working for them to build capital for a future home deposit – for roughly the same cash flow.
Andrew Zbik, senior financial planner, Omniwealth