October 07, 2016
Getting to the first rung of the property ladder is a real challenge for many young adults. With many first homes in Melbourne costing over $400,000, the traditional requirement of saving a 20% deposit (plus other buying costs such as stamp duty) implies a deposit of almost $100,000 may be necessary.
Many banks will lend more than 80% but charge borrowers “Lenders Mortgage Insurance” – a one-off insurance premium that protects the banks from defaulting borrowers but offers no protection to home buyers. The LMI premium on a $400,000 purchase by buyers with $50,000 in savings could be as much as $10,000.
So, how can parents help their kids buy this elusive first property? Most parents aren’t in a position to give their kids a large cash gift to help them avoid LMI. However, many parents have large amounts of equity in their family home and this offers the possibility of using this equity to offer a ”limited security guarantee” (LSG).
Under a LSG arrangement, parents (or other close relatives) can offer part of the equity in their home as additional security for their child’s purchase. This additional security – which is limited to a pre-specified amount – increases the total security offered and therefore reduces the loan-to-value ratio. If this ratio falls below 80%, no LMI is payable and banks may also offer a lower interest rate.
Let’s illustrate this option with an example.
Parents’ home : valued at $800,000, with an outstanding home loan of $200,000 – meaning equity of $600,000.
Child wishes to buy for $400,000. Additional buying costs of $11,000. Has $50,000 in savings. This implies a total loan of $361,000, or 90.25% of property value. LMI of $10,000 is added to the loan.
The parents offer a LSG for $100,000. This increases the value of the security offered to $500,000 (newly purchased property, plus the LSG). The loan of $361,000 is now 72.2% of the security offered, meaning that LMI is no longer payable.
There are various issues to consider before proceeding with a limited security guarantee. Call Simon Allen at Mortgage Choice on 0439 841 539 for a confidential discussion.