Banking Code of Practice tightens rules on bank of mum and dad

The new Banking Code of Practice outlines enforceable standards that customers can expect from Australian banks.

The new Banking Code of Practice is expected to reduce loans from the "bank of mum and dad" - parents lending money to help adult children buy a home.

At a glance

  • The bank of mum and dad was the ninth-largest source of home loans in January 2019.
  • The new Banking Code of Practice imposes more scrutiny on borrowers with a deposit provided entirely or in part by their parents.
  • Falling house prices in recent times have meant that parents find it more difficult to draw on equity in their own homes.
  • The new code aims to prevent parents depleting their retirement savings by funding their children’s property purchase.

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A leap in house prices in recent years coupled with the build-up in older Australians’ superannuation savings has fuelled loans from parents to adult children.

A parental loan can not only provide the deposit, but it also means that those who can raise 20 per cent of the purchase price will avoid costly mortgage insurance and probably secure a better loan rate.

However, the new Banking Code of Practice is expected to substantially curb parent loans.

What the new code has in store

The code, developed by the Australian Banking Association (ABA), outlines enforceable standards that customers can expect from Australian banks. Provisions on applying for a mortgage and guaranteeing a loan are designed to bring more rigorous scrutiny to the financial profile of borrowers.

Economist Martin North, principal of research firm Digital Finance Analytics, says the effect of these new provisions will be that adult children are more likely to have their mortgage application rejected, or be approved for a lower amount, when their parents’ money is involved.

Borrowers with a deposit provided entirely or in part by their parents can expect banks to invest more time in assessing borrowers’ savings habits.

North suspects that by asking a lot more questions around savings history, fewer “at-risk” first-home buyers will take on mortgages they can’t service.

“First-home buyers are twice as likely to default within five years if they received help from the bank of mum and dad and never developed a savings mindset,” says North.

“Suddenly, seeing money coming in from their parents might not be viewed that positively by banks, and while they might still lend money, it might be less.” 

Financial consequences for the bank of mum and dad

What should resonate loudly for advisers, says North, is the greater onus on lenders to recognise there are financial consequences for mum and dad when they help their children buy their first home. He estimates that 60 per cent of first-home buyers were receiving financial help from their parents at the height of the property market.

However, with falling house prices making it harder for mum and dad to draw on equity in their own home, the number of first-home buyers tapping their parents is estimated to have fallen threefold since 2017, to about 20 per cent. This is also mirrored in a fall in the average amount gifted by parents to their children, from A$88,000 to A$75,000 in the past two years.

Given that the number of mature-age Australians going into retirement with mortgage debt is rising, according to the Australian Bureau of Statistics, North expects the code to go some way to preventing parents from eroding their retirement savings by funding their children’s property purchase.

Based on his data, 71 per cent of parents draw down on equity in their property to put money towards their children’s property purchase, and 72 per cent offer this money as a gift. Surprisingly, where the money is expected to be paid back, North says only 15 per cent have formal documentation.

This means parents could find it harder to get their money back if there is a dispute about whether the money was a gift or a loan, and North says it also heightens the risk of loss if children separate from their partners and the property is sold, with the proceeds halved between the two mortgagees.

Source: RBA, UBS estimates.

Alternative ways for parents to help first-home buyers

In recent months North has witnessed falling house prices and record low interest rates deliver an uptick in the number of first-home buyers again accessing the bank of mum and dad. However, with more lenders choosing not to extend loans to some borrowers with a deposit from their parents, he expects the ratio to continue falling over the longer term.

Don Crellin, managing director of financial group Resolve Finance, says fewer parental loans doesn’t necessarily mean parents aren’t still involved with children’s finances.

They may have decided to help pay monthly mortgage payments as a flexible alternative to acting as a guarantor, which, if the child defaults, could see the lender asking the parents to make repayments.

Interestingly, Crellin estimates that about one in three first-home buyer loans he deals with still involves parents, with the average amount being offered by parents between A$30,000 and A$40,000. In most cases, he says these loans are accompanied with a statutory declaration that this money is a gift and doesn’t need to be repaid. In these instances, Crellin has also witnessed a heightened onus on the borrowers to demonstrate loan serviceability.

He argues that while it’s impossible to stop parents gifting their children money, the challenge for professional service providers is to suggest alternative avenues of providing help.

Other ways for parents to support their children with a home loan without funding their deposit – which may only complicate the loan process – could be to clear credit card debt, contribute to grandchildren’s school fees or pay down the adult child’s student loan debt.

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