“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.
There are a number of good reasons for using a guarantor:
- Can be perfect for first home buyers struggling to save
- You want to avoid paying expensive LMI (lenders mortgage insurance)
- You don’t have the required 5% in acceptable genuine savings.
- Even with a deposit other costs like stamp duty and legal fees means there just isn’t enough money left to get you into your new home.
Arranging a good loan with a guarantor is a complex task and you really must have professional advice – anyone who tells you otherwise lacks experience. You, your partner and your parents all have different expectations and so you want a product that is going to be the best solution for all concerned. Bank employees and some brokers only offer one solution where as we have several to choose from.
Not all lenders accept guarantors and some lenders offer guarantees that are outrageously bad for your parent.
It is all good and well for your kids to find a great loan with a low interest rate but if it comes with lousy conditions for the guarantor then you are within your rights to say – no. If your kids don’t appreciate the commitment they are asking you to making then it is possible you should re-think and definitely seek legal advice.
With a guaranteed loan there will be additional legal and document fees ( maybe a second mortgage on parents property) involved with a loan guarantee – these fees can normally be capitalised into the loan. The guarantor will almost certainly be required to seek legal and possibly financial advice ( many lenders ask for proof). Most lenders will want to see income sufficient to service the guarantee amount. Although some lenders are waiving this requirement which can be very important if Mum & Dad are at or near retirement. Most lenders will want as a minimum an asset and liability statement. Many lenders will also want a first mortgage on parents home and this means that if they have an existing mortgage they also have to go through the trouble and expense of a refinance, however again there are some lenders who are happy to take a second mortgage behind an existing lender. This will still cost around $750 but saves a lot of hassle.
Limited guarantee or unlimited guarantee
This is a very important point of difference. Lenders who take an unlimited guarantee are making your parents responsible for the full loan amount, these are common but should be avoided. A limited guarantee is for a fixed nominated amount, usually the amount required to bring the loan below LMI but maybe less and it is your guarantor’s choice.
How long does the guarantee last for and can I cancel
The guarantee will remain in place until you apply to have it removed and the lender agrees. You have to allow some time for the property to increase in value and/or the loan to be partly repaid. After a few a years as capital growth and principal repayments make a serious impact on the LVR (loan valuation ratio) and this drops to 80 percent you can apply to have the guarantee released. Releasing a guarantee will normally require a new valuation at borrowers cost and the discharge of the guarantor’s mortgage.
Offering a guarantee to help your children can be a richly rewarding experience … but get it right with our help
Being the guarantor for your children’s home can be a satisfying experience as you are not only saving them many thousands of dollars but possibly allowing them the opportunity to get into their own home at a time they would not otherwise be able to consider doing so. Despite the current affairs shock reports in our experience very few guarantees go wrong and we have never had a parent lose their home… after all it is not a good look for any of us. I would venture to say that many of the guarantees that go bad come from parents who are too eagerly encouraging young people into commitments that they are not ready for.
However if the borrowers are in secure and stable employment, if their savings plus rental payments are not too different from what their loan repayments will be then the risk to the guarantor may be small – but you know your own kids best. Don’t be rail-roaded into something that you are uncomfortable with and please speak to a mortgage broker experienced in this area rather than just accepting the advice of someone who is keen to get their commission for a loan and no interest in your needs.
Note: It has come to our attention that there can be implications with regards to pension entitlements where a guarantee is called on by the lender ( borrower defaults on loan). We strongly urge you to seek independent financial advice on this and all other implications of a guarantee.