“Hey Dad will you be a guarantor for our home loan?” This is not a new question for Mums and Dads as guaranteeing your kids loans has been a common practice for decades.
My Dad guaranteed my first car loan way back in 1972 and without that guarantee I would have never qualified for the $850 loan that paid for my two year old Mini. While many things have changed – the most obvious being the number of zeros at the end of any loan amount, young people today can still struggle to qualify for loans on their own.
We have arranged many loans for young people using parental guarantees – the legal and technical side has always been obvious however I recently became a guarantor for my own son and that gave me a new perspective on the process.
When we guarantee a child’s car loan, they are typically just starting out in the world and so probably in their late teens. However when they require our help to buy a house they are more likely to be in the late twenties or early thirties and this is an important difference because it obviously means that we (the guarantor) are ten or more years older.
In my case I am in my late fifties and like so many people my age trying to pump as much into superannuation as my lifestyle will permit. I am also a self employed contractor and to complicate matters my home is in a remote rural area in a different state to where my son wanted to buy.
The criteria for my ideal loan, as the guarantor;
- I didn’t want to have to provide two years personal and company tax returns – which is normally required for self employed,
- I wanted a partial guarantee which means rather than guaranteeing the full loan amount, offering sufficient security only to cover the gap 20% between the purchase price and the amount where mortgage insurance applies.
- I didn’t want to be forced to refinance my existing mortgage and therefore I required that the lender accept a 2nd mortgage for my guarantee
Why this criteria? Well like so many people of my age I have substantial equity in my home – in fact I could pay it off tomorrow but I choose not to as I have access to a substantial redraw which I consider a safety net. If I was forced to refinance and maintain the redraw I then have to prove I can service this debt and because of my age I may be expected to do so over a much shorter term. As a result I could struggle to show servicing and may not qualify to keep all of my safety net.
As usual not everything was as hoped for but we got through – here’s the kind of things that can throw a few spanners around.
So let’s say for example your child’s new house purchase price is $500,000 – they have some limited savings say borrowing required $490,000:
- your home is worth $450,000 but the valuer comes in at $405,000
- you have $150,000 in redraw but the lender adds 20% so it making it $180,000
- the bank requires 25% of $490,000 guarantee security = $122,500
- the guarantee plus the redraw = $302,000 which is 74.6 percent LVR
As you can see the 74.6% LVR only just squeezes in despite the fact that you may only have $10,000 in actual mortgage left to pay.
Where the real crunch will come is if my second and/or third sons ask “Hey Dad will you be a guarantor for our home loan?” Of course by then first son will hopefully have sufficient equity in his home to allow the lender to release my guarantee and free it up for the others.