What parents need to know about going guarantor on a mortgage

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I’m sure you’ve noticed that house prices have been high for some time now. In many cases that’s made it more difficult for younger 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 foot on the property ladder.

If you’re one of them, you might be letting your kids stay at home, rent-free while they save for a deposit. But lately, another option has been increasingly popular – parents going guarantor on their kids’ home loans.

According to our Bank of Mum and Dad report 2020, Australian parents are essentially the fifth biggest home lender in the country and are lending an average of $73,522 to their children in order to help them compete in the market.

When you go guarantor for your kids, it means they can use the equity built up in your home as extra security against their loan, and therefore pay less. But as popular as it’s becoming, this is a strategy that requires a big commitment and can be pretty risky for parents.

To give you an idea of what to expect I’ve broken down the advantages and disadvantages of going guarantor, along with some of my top tips for making it work.

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Why go guarantor?

ABS figures released in February 2020 indicate that the average mortgage amount nationwide needed to purchase an existing dwelling has increased to $500,000. That means first home buyers wanting to keep their LVR below 80% and avoid paying lender’s mortgage insurance (LMI) would have to save a hefty 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 many borrowers do their best to avoid. And when you add in other buying costs like stamp duty, lender and conveyancer fees as well as insurance, purchasing a first home is no easy feat.

That’s where parents as guarantors come in. Not only can it help first home buyers to avoid paying LMI, but it can also mean giving them access to better home loan rates. After all, many of the sharpest rates are only available to borrowers with an LVR of 80% or less.

Who can be a guarantor?

While they’re the most common, parents aren’t the only possible guarantor option. Different banks and lenders have varying criteria in terms of who can act as one, but generally it’s a legal guardian or family member over the age of 18 (so siblings, aunts, uncles etc.)

It’s also worth noting that some lenders do have maximum caps in terms of the percentage of the loan a guarantor can provide - for example, Westpac states that a single guarantee can only represent up to 50% of the guarantor’s security.

What are the risks?

Although having a parent or family member as a guarantor is great for young borrowers, it can be risky for the guarantor. One of the main risks is that if your child can’t make their monthly home loan repayments, you can be liable instead – at least for the portion of the loan you guaranteed.

If your child defaults on the loan, the lender will often sell your child’s home first in order to discharge the mortgage. But if there’s a shortfall, it may be your home up on the chopping block next. This is a considerable risk, so you should think long and hard before agreeing to go guarantor for your kids.

Ask yourself honestly whether 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 come up.

What are the alternatives?

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Going guarantor shouldn’t necessarily be your first choice when helping your kids to get into the property market. So before you go down that path, 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. Gift them the money: Instead of acting as a guarantor which increases your own risk, consider the possibility of providing money as a gift or an advanced inheritance which could then be put towards a deposit. Or if you’re in the position to, buying the property on your child’s behalf or as a partner with your child.

2. Help them save: If providing support in the form of a guarantor home loan or via a monetary gift is not an option, consider offering your child the option of moving back home with you and letting them live there for a reduced rent (or rent-free).

3. Consider the FHLDS: The Federal Government's First Home Loan Deposit Scheme (FHLDS) let’s first-time buyers with at least a 5% deposit avoid having to pay lenders mortgage insurance when taking out a home loan. Instead, the government will act as the guarantor for the remaining deposit amount.

Tips for parents going guarantor

  • Get some good advice: Going guarantor on your child’s home loan is a big commitment, so before you do anything else, seek out some legal and financial advice, so you’re fully aware of what’s involved. Not only is this a good idea for your own preparation, but many lenders will actually require you to do it.
  • Set a limit: An unlimited guarantee can lead to trouble, so instead of a blank cheque, think about limiting your guarantee to a portion of the property price – say 20%. That’s enough that your children can avoid lender’s mortgage insurance, but it also limits the damage done to your own savings, if for some reason your child defaults on their loan payments.
  • Find your nearest exit: Early on in the arrangement, sit down with your child and discuss when and how your part in the loan will end. One way to do it is to plan for your child to refinance and discharge the mortgage on your home once there is enough equity built up in theirs. Having this strategy in place is practical and it serves as a reminder to your child that it’s your money and home involved, as well as theirs.
  • Check on your insurance: The reality is that circumstances can change, and you should be prepared for the chance that your child may be in a position where they can’t make the repayments on their loan. Making sure your insurance is up to date and offers adequate cover is key to making sure you – and your child – will be protected if something unexpected happens.

Are your kids looking for a home loan to get into the property market? There are 500 different home loans from more than 80 lenders in our database, so start comparing rates, fees and features today by heading over to the home loan comparison hub.

*Bank of Mum and Dad lending statistics accurate as of March, 2020

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