Rising house prices are making it increasingly difficult to enter the market. Parents who guarantee their children’s loans can help, but it is important to understand how this can impact the parents’ retirement or investment plans.
Being a guarantor generally means using the equity in your own property as security for your child’s home loan. It can help a first-home buyer to secure finance for a property they can afford but may not have a large enough deposit for, and to avoid the added cost of Lenders Mortgage Insurance (LMI).
There are other advantages as well. By guaranteeing a loan, you’re helping your child enter the property market sooner. Also, your child may be able to buy in a more desirable location and a home that better suits their needs. If they did it on their own, they may need to go further out of the city or perhaps settle for fewer bedrooms.
You may want to help your child but it’s important you don’t go into the transaction blindly.
The main risk of guaranteeing the loan is that, depending on the structure of the guarantee, you could be liable should your child default on the payments, either by taking over the repayment schedule or handing over a full repayment.
If you can’t make the payments, the lender may sell the home used as security. If this is still not enough, the lender may also require you to sell assets to meet outstanding debt.
Another risk is a bad credit rating if default occurs.
Plus, if you need to borrow money for another purpose for example purchase an investment property, you can’t use the equity in your home because it’s already tied up in the child’s loan. Although this can be overcome with the right lender and loan structure.
Minimising the risk.
There are ways to minimise the risks. This could be by a monetary gift or private loan. This involves borrowing money against your property in your name, and then gifting it to your child. You should have a legal agreement in place.
Another way to minimise the risk is to buy the property jointly with your child. This means your name is on the title and you have a certain percentage entitlement. This however does not negate your responsibility to the loan repayments if it comes to that.
When it comes to guaranteeing a loan, it’s always advisable to seek a legal professional to draw up a formal loan document outlining all conditions of the loan, interest rate and expected repayments.
Have 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.