I’m sure you’ve noticed that house prices have been high for some time now, and they aren’t likely to come down any time soon. And when the market is this competitive, parents often take 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.
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. According to NAB, the number of borrowers choosing this method rose from 6.7% in 2010, to 8% in 2016.
But as popular as it’s becoming, this is a strategy that requires a big commitment and can be pretty risky for parents. In this blog, I’ve broken down the advantages and disadvantages of going guarantor, along with some of my top tips for making it work.
Why go guarantor?
ABS figures put the average first home loan amount at $335,000. That means if young Aussies want to keep their LVR below 80% and avoid paying lender’s mortgage insurance, they’d have to save a hefty deposit of at least $67,000. And that’s not even factoring in the other buying costs like stamp duty, and conveyancer and valuation fees. 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 some of the best deals on the market, which often require borrowers to have an LVR of 80% or less.
What are the risks?
Although having a parent as a guarantor is great for young borrowers, it can be risky for the parents. One of the main risks is that if your child can’t make their monthly 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.
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 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.
- Think about other options first. Going guarantor shouldn’t necessarily be your first choice when helping your kids to get into the property market. Think about other ways you can help without putting yourself at risk – like giving money as a gift or an advanced inheritance. Buying the property on your child’s behalf or as a partner with your child is also an option.
Are your kids looking for a home loan to get into the property market? You can compare first home loans to find a deal yourself, or fill in your details below if you’d like me to help negotiate a better deal on your behalf.