I was amazed to read that in survey, cited in an article in July 2012, of Australians aged over 50 that parents give $22 billion a year to their adult children to tide them over in difficult times and help them buy their first home.

Big help

I would like to focus on how parents can assisted others (not just children or grandchildren) to become first home buyers. Firstly, I need to define some industry jargon. The term LVR means loan to value ratio or the amount of money borrowed as a percentage of the property valuation. If a bank allows a loan of $365,000 against a home valued at $400,000 then the LVR is 91.25%.

Getting rid of LMI

Prior to the gfc LVR’s of 99% were common but the lenders have tightened their policies so in many cases 95% is the maximum. If you borrow at a higher LVR than 80% you will pay a fee known as Lenders Mortgage Insurance. This insurance premium covers the bank against any losses if you default. All a borrower receives is a loan approval.

LMI is charged on sliding scale with a number of factors. The more you borrow the more you are charged and the higher the LVR the more you are charged. It is possible to pay over 5% for lmi. I chose a random lender with an LVR over 94.1% and a loan amount of over $2m – so that adds over $100,000 to the purchase price.

Gift, Loan or other

A parent does not necessarily have to provide a non-refundable gift or interest free loan to remove the lmi fee. In fact in my experience it is best not to provide a gift at but rather assist by giving up a little equity in your property.

Using the example above, if a parent is willing to surrender $45,000 in equity in either their home or another residential property then the borrowers will save at least $9467 using the premium from our random lender.

By using a Family Guarantee it may assist the first home buyers to live closer to their parents, purchase in a better location or avoid settling for a cheaper alternative.

Structure

I recommend that borrowers have 2 loans. One variable loan linked to an offset account which is interest only for 5 years over a 30 year loan term at an 80% LVR and a second loan fixed for 5 years over a 20 year (give or take) period for the balance. Why?

Firstly, I am hoping to keep the repayments at the same level as a principal and interest loan over 30 years. Secondly, I am reducing the exposure to the parents’ property by accelerating those particular repayments. After 5 years I recommend a re-valuation of the property and with the equity that has been created re-finance and remove the parents’ exposure.

Insurance

Regardless of the method used by parents to assist their children to purchase their first home, life insurance on the lives of the children and their parents should be considered. If sickness or an accident occurs to anyone who has just purchased a home it is difficult to meet the mortgage repayments. This is especially true of first home buyers. The consequences are compounded if parents have provided funding, one way or another, as they may are legally responsible for a portion of the debt but may feel duty bound to meet all of it and assist with living and medical expenses.

A final note

On the positive side given the age of the children, insurance premiums should be relatively low. Certainly, they will be significantly lower than the LMI premiums. There is another way that parents can assist with a gift that may be a great tool to help kick start your children’s savings program. The First Home Saver Account is a tax effective way to save for a home. It has lower tax thresholds and savings bonuses. Take care if you’re heading to Centrelink for an aged pension as there are specific gifting rules. So, like in all cases when it comes to financial matters ensure that you have appropriate advice from suitably qualified professionals.