Agony Aunt: The bank of mum and dad for a mortgage

Dear Janine

My wife and I are in a conundrum.  Do we, or don't we, loan money to one of our children for a house?  We have a 28 and 30 year old and both have good jobs.

The older one has a home, but the younger one can't seem to get there, as rents are so expensive.

We are mortgage free, in our mid-50s and have saved $200,000 towards retirement.

Our son and his wife would like a family-funded mortgage of $100,000 and will make repayments over 10 years so the money is back in our account when we retire. It would be interest free.

We have the money available and it would feel extremely awkward saying no, given how hard it is to get on the housing ladder. We trust them to pay it back, but what pitfalls can you see?

ANSWER:

No pitfalls at all – for them.

What a great idea they've come up with and I'm sure it would suit them nicely.

My reservations are badly veiled aren't they. Hopefully all parties are open to thinking about other options. 

There's a theory on family-funded mortgages. If a bank won't lend it to them, it's fairly likely they can't afford to repay it.

Parents entering this sort of arrangement need to be wealthy enough to write off a loan as a gift, if push comes to shove.

Your son has offered to pay it back over 10 years. Why can't he afford an additional 25-year mortgage for the $100,000?

Maybe their incomes are high enough, but they have zero deposit.  It seems unlikely they'd be spending $500,000 on a first home (given you are not in Auckland), so I find the requirement for $100,000 (20 percent) to be rather steep.

Are they using their KiwiSaver funds towards a deposit?  And what about the inlaws?  Have they also been asked to put up half their retirement fund to help out?

The pitfalls for you:

Loss of returns: by not earning interest on $100,000 you are giving up significant gains over a 10-year period.

For example, losing a 3 per cent net return costs you $34,000, 5 per cent costs $62,000 and losing 7 per cent really bites; $96,000.

Depending on the risk you take, you could have doubled your money in this time period.

Inflation proofing: in 10 years when prices have risen, your $100,000 is likely to have a value closer to $80,000 in today's money.

Credit risk: any sign of thunder on the horizon and guess whose repayments are the first to be shelved?  Whether it's job losses, babies or critical renovations, the bank of mum and dad is the first to feel the pain.

You both die: unlikely, but it needs to be accounted for with legal agreements if you've made an interest free loan to one child and not the other.

Divorce: agreements must be in writing. If your son divorced you wouldn't want your money muddled into their relationship property.

The other sibling: your 30-year-old is currently paying mortgage interest. Even if there are wealth differences, you still need to address the fairness of this as a family. Would you give them the same deal?

Retirement fund is not large: your $200,000 is nice, but not substantial. It is not unfair to prioritise yourself this late in the savings cycle.

The crucial years: the 10 years prior to retirement need to viewed as turbo-blast saving years.  You will never earn more or have more disposable income. This can give a false feeling of wealth. There are 20 to 30 years ahead and investment returns are crucial.  

Other options

These all have different implications and pitfalls.  Discuss with your family lawyer.

- A small gift: is it better to write off a small amount as gift and give the same to both children?

- A guarantee: if the deposit is a problem for your son, you can secure it over your own house.  There's no cash outlay. As soon as they've gained some equity in the property, ensure this is released. 

- Springboard mortgage: this is where parents provide security over a term deposit with the same bank. You keep earning interest on your deposit, but can't touch the capital. Your money is at risk if they can't meet their repayments or sell at a lower price.

- Offset Mortgage: same as above, but you also give up the interest on your deposit, to offset your sons mortgage interest. While it keeps your savings intact you still suffer a loss of investment returns. 

- $100,000 ownership: the house is valued or sold in 10 years to release any capital gains. Your son can remortgage to pay you back with your share of gains.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.