A family guarantee for a home purchase
Saturday 25 May 19
You have probably heard about someone being a “guarantor” for another person’s loan. They are making a guarantee somewhat similar to how a manufacturer will guarantee their products. It doesn’t mean that their products will never fail, it just means that if they do, the one giving the guarantee will make it good.
Such guarantees are provided with some loans. For example, a director of a company may be required by the bank to be a guarantor for a loan borrowed by the company. The bank would be a bit wary of lending the money without that, because if the company went bust, then they would have no-one to chase to get paid. With the guarantee, the director would be responsible for the repayment if the company was unable, or unwilling to do so.
However, not just anyone can be a guarantor, and even in the situations where it is allowed, it’s not going to be accepted unless the one borrowing appears to have the ability to repay the loan without help. After all, would you buy a car just because it had a guarantee, when it was quite evident that the engine was going to blow up soon?
One of the types of guarantees that is allowed is a family guarantee. It’s designed for young first home buyers to be helped by a parent. With it, the young borrower can generally borrow up to 100% of the costs of purchasing the home – even above the home’s value. So, how does it work?
First of all, you need to understand what a “Loan to Value Ratio” or “LVR” is. If you don’t know about that, click here to read the relevant article.
Having to pay “Lenders Mortgage Insurance” (“LMI”) is going to be an issue, and the Family Guarantee helps you to avoid that. Generally, what will happen, is that the loan will have two parts.
One loan part will be for 80% of the value of the property being purchased, and the borrowers for that part will just be the first home buyers, without any guarantee. It’s totally their responsibility, and the bank will not be chasing anyone else for that.
But to allow the full lending and also to avoid the “LMI”, the second part will include the parent’s property along with the home being purchased as security. In a sense there are two things backing up the loan. You have the parents signing the guarantee, entering a binding legal agreement that says they will make good the loan payments, if the kids fail to do so. But they are also putting their own property on the line. If everything and everyone else comes up short, their property could be sold to come up with what’s needed to repay that part of the loan. Pretty serious stuff.
So, who can be a guarantor for a first home buyer needing a Family Guarantee?
For most lenders, it must be a parent. A few might allow some other very close family members, but it’s very important to the bank that the person providing the guarantee has vested interest in the success of the first home buyers. That sort of interest is generally there for a parent with their child. Perhaps a bit of metaphorical whip cracking to keep the kids on track, but whatever it is, it’s a lot more than your best mate or even your boss at work figuring you are a nice bloke who should be given a loan.
We have referred to the borrowers being young, but while that is typical, there is no age limit. However, you can have issues where the parents are nearing, or in, retirement and don’t have the means of making the loan repayments if they were called upon to do so.
Be aware that the lender is likely to require the parents to get independent legal and financial advice. They don’t want it to come back and bite them if everything hits the fan, and the parents then say, “but you never told me…”
By now I may have convinced Mum and Dad not to touch a family guarantee with a ten foot pole, but that’s not necessarily the case. To enter into one, parents should consider the following:
- What is the overall impact going to be on my children? Is this going to give them the ‘leg up’ that they need to achieve success and enjoy family life? Or is this going to entrench them into a welfare mentality where they don’t learn to stand on their own two feet?
- If everything did hit the fan, what would be the impact upon us? Do we have resources apart from the value of our home that we could apply to fully repay the portion of debt that we are guaranteeing? If we don’t have the capital, do we have enough employment income for long enough to be able to borrow that amount ourselves and repay it without significant distress?
- Would we be more comfortable with a situation where we either give or lend that money to our children, and they are simply responsible for paying us back for that portion? Note, for this to work, the bank is probably going to require the kids to come up with some of their own savings, and the bank will still require them to have the ability to repay the full amount of all loans, including ones to the family, at the bank’s assessment rate.
Naturally, a lot of factors are involved. Feel free to make an appointment with us, and we will be happy to discuss them with you.