Glenn Stevens has just stepped down from his role as the Governor of the Reserve Bank. It has been his job to monitor the economy for the last several years, and then to set interest rates accordingly. He probably knows more than any other Australian about housing affordability and how hard it is for young people to buy homes.
Stevens gave an interview this week. In the interview he agreed that it is almost impossible for a young first home buyer to buy a house in Sydney (where he lives) without parental support. The situation may not be quite as bad in the other capital cities – but it is still very difficult for younger people to buy a first home. Many, if not most, young first home buyers use some form of parental or grandparental support to help with the purchase.
This kind of parental support is really a way of bringing forward the benefits of a young person’s inheritance. The Grattan Institute have reported that most people who receive inheritances are aged in their 50s or 60s. This makes sense as it means that the last remaining parent died in his or her eighties or even nineties. As elderly mums and dads live longer, inheritances are passed on later in their children’s life.
Living longer makes the elderly wealthier – as long as they own a home. 43% of total private wealth in Australia is locked up in the homes that people are living in. Because older homeowners hold their homes for longer periods, the increase in the value of that home compounds over a longer period.
Put these two things together and you see that people are inheriting more from their parents than they ever have before – but that they are receiving that inheritance in the fifties or even their sixties, well after their own peak cost years have passed.
This all sets the scene for families to look to assist across the generations before the older generations pass away – which is what Stevens is observing in the Sydney market where he lives. And this kind of assistance is something that parents are usually keen to provide… if only so that their grandkids live closer than they otherwise would!
There are various ways for older generations to help out younger generations. Some make more sense than others, and so it pays to really do your thinking about how assistance should be given. Straight out gifts are almost always bad news – especially if there is a partner involved.
One very simple way is for mum and/or dad to use their own savings account to offset their children’s mortgage. In essence, this becomes an interest-free loan that saves the younger person the amount of interest that they would have paid on their own home loan. For example, mum and dad might have say $40,000 in a savings account. The money is perhaps earmarked for their own retirement holiday or a new car in a few years’ time. Allowing this money to offset their adult child’s mortgage will save that child around $2,000 a year in interest to the bank. This interest is not tax deductible, meaning that someone paying marginal tax rate of 30% has to earn $2,800 in order to pay it. If the young person keeps up the same level of repayments, then they will find themselves reducing the principal of their loan by $2,000 a year. Over 14 years, this will save a further $2,000 in interest payments.
The key benefit is that the money in the savings account remains mum and dads. It does not really cost mum and dad anything to use their money like this. If they left it in a savings account in their own name, they would receive no more than $100 or so in interest. Giving up $100 to save your kids $2,000 is a bit of a no-brainer.
This is just one of the many pain-free and low-risk ways that older generations can help younger ones. There are also some very high risk ways that should be avoided (straight out gifts of cash to the adult child are almost always a bad idea). It is important that you do the right thing in the right way.
So, if you would like to help your children to buy their own home, make sure you give us a call so we can discuss the very best way to do so.