How the Bank of Mum and Dad can help you buy your first home

Chances are you have already heard of what is casually known as the 'Bank of Mum and Dad'. This term is used to describe financial and legal support provided by older (often retired) parents to their adult children to purchase a property - particularly their first property where the constraints to getting that first step on the property ladder are greatest.

In reality, financial support isn't restricted to coming from parents - it could be grandparents, aunts and uncles, older siblings or any other relation. Parents are simply the most common providers. 

While there can be significant benefits to this form of financial assistance, it is not foolproof nor guaranteed to result in everyone living happily ever after. 

Let's take a closer look at some of the assistance options, as well as strategies that can be implemented to help ensure the Bank of Mum and Dad works fairly and financially for everyone involved.

Types of assistance 

The Bank of Mum and Dad has multiple tools at its fingertips to support those seeking assistance. 

Money for the deposit

Contributions towards the deposit are perhaps the most common and obvious option. This money could be provided as a gift, particularly if it is tied to a major milestone - making it a wedding present or surprise to mark a milestone birthday. Alternatively, it could be offered as a loan, complete with a repayment schedule. Interest may or may not be added, depending on the circumstances of both sides. 

Going guarantor

A guarantee over the mortgage is another means of assistance. Under this scenario, parents (or whoever is providing the support) offer to guarantee repayment of the borrower's mortgage and use an asset of their own as collateral. This is typically used when someone wants to support the younger person's property aspirations but lacks the financial resources to do so. 

Buying the property - alone or as co-purchasers

Another option is for the Bank of Mum and Dad to buy the property themselves on their child's behalf or go in as a co-purchaser. The adult child lives in the property while the older generation uses the property as an investment, with the aim of pocketing the capital gain once it is eventually sold. Alternatively, a 'rent-to-buy' situation could be put in place, where the adult child pays rent, which is treated as loan repayments. Over time, they pay off the purchase price or refinance to a traditional lender once they are in a position to do so. 

Ensuring the arrangement works for everyone 

While the intentions of the Bank of Mum and Dad are generally good and noble, handing over large sums of money and/or entering binding legal guarantees and contracts are not without substantial risks - even where family is involved.

Provisions and protections need to be put in place to cover any future increase in spending needs or hit to income levels - both for those providing the assistance and those receiving it. 

This should be done at all stages of life regardless, but it becomes even more important when adult children take a chunk of savings or home equity out of the equation. 

Both sides should also update their wills and estate planning to reflect the new situation. The Bank of Mum and Dad may need to adjust what each of their children will inherit to make things fair and equitable. Meanwhile, updating their will is essential for every new property owner. That may mean declaring any benefit the Bank of Mum and Dad are owed or entitled to receive from the property. 

Some parents don't like the idea of making money in interest from their own children. However, they may not be in a financial position in the long term to gift them part or all of a property deposit. Only requiring repayment of the principal amount will dilute the value of that money over time thanks to inflation. A workaround that can suit both parties is to have the interest set at the inflation rate of the day. This means that the Bank of Mum and Dad is no better or worse off financially, while the borrowers typically pay a lower interest rate than they would on a traditional bank or personal loan.

More than anything else, though, you must put your agreement in writing and have it signed by all parties. It is easy to shrug this off, thinking, 'It'll be fine, they're family'. Don't forget, this is a financial contract with a lot of money and legal responsibility attached to it. As such, it should be appropriately documented, just like any other financial matter. This is to ensure that everyone is fully aware of and clear on what the agreement is, what is reasonably expected of everyone, and what the support being provided by the Bank of Mum and Dad actually entails. It also serves to prompt everyone to look at things from a logical perspective instead of an emotional one.

Specify whether any money being provided is a gift or a loan. If it is a loan, outline whether and how much interest is to be applied, when and how often repayments need to be made, and when the loan is expected to be repaid in full. Include contingency plans should the property be sold, someone's relationship breaks down, or a change in circumstances (like illness or redundancy) impact the ability to meet repayments. 

One final point: before agreeing to anything, consider whether the Bank of Mum and Dad is necessary in the first place. A mortgage broker may be able to find a workable lending solution for the borrowers. Alternatively, a creative approach such as rentvesting or buying with friends or siblings may provide an alternative means of getting into the property market. Don't let tunnel vision lock you into pursuing a particular path that may or may not be in your or your loved ones' best interests.

This is an edited extract from Money For Life by Helen Baker (Major Street Publishing $32.99), republished with permission and available at all leading retailers.