I’m sure you’ve noticed that house prices have been high for some time now. In many cases, this has made it harder for young Australians to enter the market for the first time, meaning parents across the country have taken it upon themselves to help their children get a foothold on the market. property scale.
If you’re one of them, you can let your kids stay home, rent-free, while saving for a deposit. But lately, another option has become increasingly popular: parents vouch for their children’s home loans.
According to our 2020 Bank of Mum and Dad report, Australian parents are essentially the fifth largest home lender in the country and lend an average of $73,522 to their children to help them compete in the marketplace.
When you vouch for your children, it means they can use the equity built up in your home as additional security against their loan, and therefore pay less. But as popular as it gets, it’s a strategy that requires a lot of commitment and can be quite risky for parents.
To give you an idea of what to expect, I’ve broken down the pros and cons of being a guarantor, along with some of my top tips for making it work.
Why become a guarantor?
ABS figures released in February 2020 indicate that the average mortgage amount needed nationally to buy an existing home has risen to $500,000. That means first-time homebuyers who want to keep their LVR below 80% and avoid paying lender’s mortgage insurance (LMI) should save a sizable deposit of at least $100,000.
Lender’s mortgage insurance alone can cost borrowers thousands or even tens of thousands of dollars, which is why it’s a cost that many borrowers do their best to avoid. And when you add in other buying costs like stamp duty, lender and assignee fees, and insurance, buying a first home is no small feat.
This is where parents come in as guarantors. Not only can this help first-time home buyers avoid paying IMT, but it can also mean giving them access to better home loan rates. After all, many of the highest rates are only available to borrowers with an LVR of 80% or less.
Who can be a guarantor?
Although they are the most common, parents are not the only possible guarantor option. Different banks and lenders have different criteria for determining who can act as such, but it is usually a legal guardian or a family member over the age of 18 (so siblings, aunts , uncles, etc.)
It should also be noted that some lenders have maximum caps in terms of the percentage of the loan that a guarantor can provide – for example, Westpac states that a single guarantee can only be up to 50% of the guarantor’s guarantee.
What are the risks ?
Although having a parent or family member as a guarantor is ideal for young borrowers, it can be risky for the guarantor. One of the main risks is that if your child can’t make the monthly home loan payments, you may be liable instead – at least for the portion of the loan that you have secured.
If your child does not repay the loan, the lender will often sell your child’s home first to clear the mortgage. But if there’s a shortfall, it might be your next house on the chopping block. This is a considerable risk, so you need to think long and hard before agreeing to vouch for your children.
Honestly ask yourself if you trust your children to be financially responsible, and make sure you’re in a position where your savings can comfortably cover any problems that arise.
What are the alternatives ?
Being a guarantor shouldn’t necessarily be your first choice when helping your kids get into the real estate market. So before you go down this road, think about other ways you can help without putting yourself at risk, as well as some of the other options that might be available.
1. Offer them the money: Instead of acting as a guarantor, which increases your own risk, consider the possibility of providing cash as a gift or an advanced inheritance which could then be assigned to a deposit. Or if you are able to purchase the property in your child’s name or as a partner with your child.
2. Help them save: If support in the form of a guarantor home loan or via a monetary donation is not possible, consider offering your child the possibility of returning to your home and letting him live there for a reduced rent (or without rent). ).
3. Consider the FHLDS: The federal government’s First Home Loan Deposit Scheme (FHLDS) allows first-time buyers with at least 5% down payment to avoid having to pay mortgage insurance to lenders when taking out a home loan. Instead, the government will act as guarantor for the remaining amount of the deposit.
Advice for parents who become guarantors
- Receive good advice: Being the guarantor of your child’s home loan is a big commitment, so before you do anything else seek legal and financial advice so you are fully aware of what it entails. Not only is this a good idea for your own preparation, but many lenders will ask you to do this.
- Set a limit: An unlimited warranty can cause problems, so instead of a blank cheque, consider limiting your warranty to a portion of the price of the property, say 20%. This is enough so that your children can avoid mortgage insurance from the lender, but it also limits the damage to your own savings if for some reason your child does not repay their loan.
- Find the nearest exit: From the start of the arrangement, sit down with your child and discuss when and how your participation in the loan will end. One way to do this is to plan that your child will refinance and cancel the mortgage on your home once there is enough equity built up in theirs. Implementing this strategy is practical and reminds your child that it is your money and your house that are at stake, as well as theirs.
- Check your insurance: The reality is that circumstances can change and you need to be prepared for the possibility that your child may find themselves in a situation where they cannot repay their loan. Ensuring your insurance is up to date and provides adequate coverage is key to ensuring that you and your child will be protected should the unexpected happen.
Are your children looking for a home loan to get started on the real estate market? There are 500 different home loans from over 80 lenders in our database, so start comparing rates, fees and features today by visiting the Home Loan Comparison Center.
* Mom and Dad’s Bank loan statistics accurate as of March 2020