Guarantor on your child’s home loan? Read this first!
There may be many reasons you’re looking to go guarantor on your child’s home loan. It may be that you see them struggling to save for a large deposit, (although their easily able to make their own rent and utilities). It may because they’ve been taking up too room in your house, driving you crazy and it’s time for them to find their own independence! Perhaps they’ve had a family of their own and you’d like to release some equity in your home, that helps set them up for life.
Increasing house prices have made it harder and harder for younger people to make it onto the property ladder. Parents providing ‘guaranteed’ loans is becoming almost a norm. No matter how good your intentions, you need to understand how this could affect your home, retirement, investment plans and you need to understand all your options.
Becoming a guarantor is not something that should be taken on lightly. In this Bear Loans blog, we’ll talk about how this finance works, the risks involved and some great alternative options, as well as your essential exit plans.
How this loan works
By becoming a guarantor, you’ll be using the equity you’ve built in your own property, as security against your child's home loan. In other words, your helping to protect the bank from loan default by placing money from your home, ‘on hold’ to be released in case something goes wrong or your child is unable to make the repayments.
Why be a guarantor?
By doing this you can help your child secure a home they can afford but don’t have the deposit for. It reduces the amount of mortgage insurance they would need to pay, they may be able to buy a bigger property or buy somewhere closer to you and it will get them into the property market sooner.
It’s a positive and incredibly generous thing to do but it’s important that you don’t go into this transaction blindly. Depending on the loan and guarantee structure, you could end up having to take over any mortgage repayments. Your credit score could be affected by any loan default. If the loan can’t be serviced the lender may sell the house used as security and if this isn't enough, may require further assets to be sold too.
Your borrowing ability is also affected. You wouldn't be able to borrow money against your equity for any other purpose, such as an investment of your own or even in an emergency, as it will be tied-up in your child's loan.
You need to bear in mind that if your child decides to sell the property, having a guarantor might complicate the process. Plus, if your child is purchasing a property with a partner or a de facto, that partner could be entitled to money, should they break up and/ or sell their home.
Reducing Your Risk
Luckily there are several ways we can help you reduce your risk -
Protect your guarantee by placing a limit on it. This way you’re only responsible for part of the loan. You can also ask to be released if your child has paid back over 80% of their mortgage.
You can create a private loan from the equity in your home and gift the monies to your child. This could be repayable and to arrange this you would need a legal agreement in place. The benefit is your left in control of any equity in your home, should anything happen to your child’s ability to make the repayments.
You could also consider buying an investment property and letting your child live there for reduced rent or perhaps you could jointly purchase a property with them. The plus side, would be your name on the title, meaning you have a certain percentage entitlement in the equity and if the house was to be sold.
There are other types of loan options available too. There’s a Family loan, allowing a parent to assist with security and or serviceability or Parent-to-child loans. Together with the lender, you formally lend money to your child and have a stake in the property. You receive principal-and-interest repayments on the amount that you lend them.
The importance of your Exit Strategy
Finally, outline an exit strategy. Financial situations change and, as the loan decreases with repayments, there may be an opportunity for you to withdraw your support to free up your assets without impacting your child’s loan. We talked about the guarantee limits previously but another agreement could be that if selling the home, your son’s initial deposit and your gift would be repaid and any remaining profits would be shared.
If purchasing a property together, you need to understand the difference between joint tenants and tenants in common and ensure that you stipulate joint signatures on any redraw facilities and/or offset accounts. You can be ‘Joint Tenants,’ which means you own the property in equal shares or ‘Tenants in Common’ meaning, you own the property in any proportion you like. It’s important that you seek legal advice when writing these agreements up and to understand the implications these terms have on your wills, if someone was to pass away, as each ownership type has different rights.
If you’re looking to help your child purchase a property, Bear Loans are here to offer you options that suit your personal circumstances. However, we always advise you to seek legal counsel to draw up any formal guarantee, gift or family loan agreement. This will include all conditions of the loan, interest rates and any expected repayments.
By understanding what’s involved in this process and by going into this armed with all your options and knowledge, you can relax a little more, knowing you can help a loved one get ahead and provide the support so many of them need. If you’d like to discuss any of this further or want to find out more, don’t hesitate to contact us for a chat today.
This information is not to be relied upon without speaking to your finance broker, tax agent or financial adviser.