Are you a parent who’s looked up guarantor loans, eager to assist your adult child in entering the property market? This comprehensive guide is tailored just for you.
With soaring property prices, many first home buyers worry they may be priced out of the market. Does the Australian dream seem unattainable? While it may feel that way for some, there’s good news for parents of adult children – guarantor loans offer a viable solution. By becoming a guarantor, you can extend a helping hand to your child.
Let’s delve into the world of guarantor loans and explore how adult children can receive support from their parents to secure a home loan.
How to take advantage of historically high interest rates
As of this writing, Australia is in the middle of an 11-year high of 4.1%. Needless to say, this has put a lot of pressure on homeowners to keep servicing their mortgages. It has also dampened the enthusiasm of first home buyers who are finding it even harder to save an adequate amount of cash for the crucial mortgage deposit.
Meeting home loan repayments is one thing; being able to put upfront cash to enter the market in the first place. So in times of financial hardship and increasing mortgage costs, parents who want to help their adult children enter the property market can still utilise their capacity to act as guarantors. While the current economic climate may present challenges, guarantor loans can provide a viable solution.
All about guarantor loans
Many parents, especially Baby Boomers, have experienced historical capital growth in their properties during the past 25 years and this means you may have built up quite a lot of equity that you can draw on. With a guarantor home loan, you would use some of your equity to guarantee the difference between cash/savings your child has and the lender’s deposit requirement.
What are guarantor loans?
A guarantor loan is a type of home loan where a third party, typically a family member, acts as a guarantor for the borrower. The guarantor provides additional security for the loan by offering their own property or assets as collateral.
A guarantor mortgage is often used by first home buyers who may not have a substantial deposit or have difficulty meeting the lender’s borrowing criteria. By having a guarantor, borrowers can access larger loan amounts or avoid paying lenders mortgage insurance (LMI) – either fully or partially. This works by reducing the required loan to value ration (LVR) of the mortgage.
What is a guarantor?
Guarantor meaning: the home loan guarantor is responsible for guaranteeing the loan and is legally obligated to repay the loan if the borrower defaults. The guarantor’s property or assets are used as security for the loan, providing an additional layer of protection for the lender.
How does a guarantor work?When you act as loan guarantor on another person’s mortgage, the lender will use some of the equity in your property to be counted as extra “security” on their home loan. This means the lender has a mortgage over your child’s property, and also over your property. These days, guarantees don’t usually work that your whole house is used as a security. It is typically limited to a certain agreed amount, e.g. 20% of the child’s property price and the remainder of the loan remains with your child’s name, not yours. |
Who can be guarantor?Lenders have specific criteria for accepting guarantors. Generally, they prefer:
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The guarantor’s liability can be released once certain conditions are met. This typically includes the borrower establishing sufficient equity in their property, meeting specific repayment milestones, or refinancing the loan to remove the guarantor’s obligation.
Guarantor loans involve significant financial commitments and potential risks for both the borrower and the guarantor.
Potential downsides of acting guarantor
While acting as a home loan guarantor can be a generous and supportive gesture, it’s important to consider the potential downsides and risks involved:
- you could be required to make the loan payments on their behalf or be pursued for any outstanding debt
- if the borrower fails to make the loan repayments, it could lead to missed payments or defaults on your credit history
- your ability to secure credit for your own needs, such as obtaining a personal loan or purchasing another property could be compromised
- you may be subject to legal obligations and restrictions
- the guarantor is released from their obligations once certain conditions are met; however, this process can take time, and it may not be possible to exit the guarantee arrangement until these conditions are fulfilled
Perhaps the biggest risk is having your parent-child relationship strained. Financial matters can sometimes strain relationships, even within families. Better to put systems in place in case your child encounters difficulties repaying the loan or there are disagreements regarding financial responsibilities.
Other options if you can’t help your child get a guarantor home loan
Turn to the ‘bank of mum and dad’ for a private loan
Your adult child can ask for your financial help in the form of a private loan, essentially having you fulfill the role of a private lender. You can have a formal loan agreement drawn up, outlining the loan amount, repayment terms, and any applicable interest rate. The adult child will need to repay the loan to their parents over an agreed-upon period.
Using your home equity
One of the first steps to understanding how you can assist your child with their property dreams is knowing how much equity you have in your home. Knowing how much equity you can access will help you understand how much wiggle room you have for your own financial position.
You can use your equity in a number of ways:
- as a cash gift
- a parent-to-child cash loan
- going as a guarantor
Big non-refundable gifts
Banks prefer to lend to first home buyers with a 20% deposit. Although these days there are many options to get a mortgage with a lesser deposit, these options generally attract Lenders Mortgage Insurance (LMI). On higher property prices, that LMI can add up.
If you are in a good financial position to gift your children cash for the full or a partial amount of their required deposit, this can alleviate the need for LMI (or it can get them closer to 20% so their LMI is not as high).
The important part of this gift for banks to see it as a secure option it must be a non-refundable gift. All parties must demonstrate via an agreement that it is a gift with no strings attached, it must be clear it is not a loan to be paid back at a later date.
Usually, you can sign a statutory declaration to say your child is not required to repay the deposit so the lender can assess it as a non-refundable gift.
The issue with a “loan” gift of money is that having to pay it back to you may mean your adult child may not be able to meet loan repayments, and lenders don’t want to take that default risk. You can gift this money with cash savings or you can access your home’s current equity and draw cash out for the gift.
Have your child live with you rent-free
By not paying rent, the adult child can save a significant amount of money toward a deposit for their own home. The savings can accumulate faster, allowing them to reach the required deposit amount sooner. A larger deposit can also improve their loan eligibility and potentially help them secure more favourable loan terms.
Lenders assess the borrower’s debt-to-income ratio, which compares their income to their existing debts. By not having rental expenses, the adult child’s debt-to-income ratio may improve, increasing their borrowing capacity and making it easier to qualify for a home loan.
Let us help you make your child’s homeownership dreams come true!
If you are in the financial position to help your adult child purchase their own home, and are ready to take on this financial commitment, our team at Sunshine Coast Financial Solutions can help.
We specialise in these types of loans, and we will be able to provide you with the guidance and assistance you need to make your children’s homeownership dreams a reality — with the least stress possible!
