As parents, we want to launch our children into the world of real estate at the right time. We want to teach them the principles of creating wealth through property without causing them undue stress.
It’s important to teach kids about real estate investing in a responsible way that will give them the basics, but not put them at risk or endanger our own finances as parents.
As the saying goes: ‘If you give someone a fish, you feed them for a day. If you teach someone to fish, you feed them for a lifetime’.
Getting children into property while they’re young will educate them about the benefits of real estate investing and show them how their wealth will snowball over future successes.
There are five basic ways to get your children into real estate:
- Gift money to them
- Jointly buy and jointly guarantee
- Act as an agent or nominee for them
- Borrow and sub-lend to them
- Act as a guarantor.
Gift money to them
If you’re fortunate to have enough cash, buying a property for cash and giving your children unencumbered real estate would be a wonderful start to their life.
If you have grown children, you probably bought your first property for tens of thousands of dollars, rather than hundreds of thousands. Today, just getting a deposit together is the major obstacle for children wanting to buy property.
Gifting the whole deposit to them in one amount doesn’t actually help, as most banks now require at least 5% of the deposit to come from a saving history over three months. With that 5% and the First Home Owner Grant, they still need 10% equity before banks will lend the balance. So you should add money to your children’s account slowly to demonstrate savings over at least three months.
However, even with this contribution to the deposit, the banks still need to be sure that the children can pay off the debt. A bank wants to see no more than 30% of their income allocated to mortgage repayments.
So gifting the deposit to your children is only the first step. They must still be able to service the debt.
Jointly buy and jointly guarantee
Sometimes, if children can’t afford to pay a property loan themselves, the parents will split the cost of the property with them 50/50. This way, the children pay only half of the mortgage.
If you do this, you can make an arrangement, such as having the children pay a regular amount to you to cover the equity you’ve put into the property. However, the problems with this option are numerous.
For example, if the children default on the loan, you are liable for the entire loan. Some parents, particularly those at retirement age, prefer not to act as co-guarantors due to this default risk.
Additionally, you can’t use this property for negative gearing purposes because the children occupy the property. The ATO says this is leasing to ‘An Associated Entity’, so mortgage repayments aren’t tax deductible.
As the children are considered owner-occupiers, they are free of capital gains. However, your capital gain is taxable as you don’t live there.
Act as an agent or nominee
If your children are under 18 years, you can buy a property as a nominee (now called an ‘agent’) for the child. The property is then leased out.
The strategy is that the property will become a long-term nest egg for the child. When they reach a certain age, say 21, they will inherit the property or the liability attached to the property.
This option is a good one, as the property is leased to a tenant until your children come of age, and you pay any difference between the mortgage repayment and the tenant’s rent (minus outgoings). This allows you to educate your children about property ownership, wealth creation, tenancy problems and more while they’re young.
The agency agreement may be structured more formally once the children inherit the property.
Borrow and sub-lend to them
Some parents choose to borrow against their property and gift or lend that money to their children. If the children are over 18, they can use this money as equity in the property and own the property in their own name.
This gives the children the benefit of any capital gain that may eventuate when they sell the property. You don’t get the benefit of negative gearing, but there is a limit to the liability (the amount that you can gift to your children). This limited liability may reassure parents who are approaching retirement age.
Act as a guarantor
If parents have considerable equity in their main residence, they may decide to guarantee their children’s loan. Together, the equity in the children’s property and the supplementary, guaranteed equity in the parent’s property may be enough for a bank to lend them money.
This requires no money to be borrowed and may tip the scales to enable your children to buy a property – if they are over 18 and have sufficient income.
Of course, there is a potential liability. If the children can’t make the mortgage repayments, the banks will approach you as guarantors to pay the loan.
Getting professional advice
Before choosing any of these options, you must talk to your accountant, mortgage broker or bank to determine the best outcome for you and your children. The goal is always to minimise potential risk and liability for you as a parent.
If you do this well, you can launch your children into the real estate market responsibly, appropriately and at the best time to educate them about gaining wealth through property – without exposing them to a financial burden they can’t meet!
If you have any queries or would like assistance with the purchasing process, contact Alan Bourke or anyone from Bourkes on (08) 9474 2000.