Rising house prices are making it increasingly difficult for the next generation to enter the market. An increasingly common way for parents to assist their children to enter the market is via a guarantor loan. Although there are significant benefits of this loan structure, it is important to understand how this can impact the parents’ financial position too.
Being a guarantor generally means using equity in the parent’s property as security for their 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.
There are other significant advantages:
- This structure allows the new purchaser to avoid paying Lenders Mortgage Insurance
- Recent jumps in house prices have seen many getting priced out of the market as they can not keep up with the deposit requirements to get into the property. Guarantor loans avoid the need for large deposits as the parent’s property is used to secure the loan
- You may be able to buy in a more desirable location and a home that better suits your needs. If you purchased on your own, you may need to go further out of the city or perhaps settle for fewer bedrooms
Parents may want to help their child but it’s important that all risks are clearly outlined so they don’t go into the transaction blindly.
The main risk of guaranteeing the loan is that, depending on the structure of the guarantee, the parent could be liable should their child default on the repayments, either by taking over the repayment schedule or handing over a full repayment of the outstanding debt.
In the event you can’t make the repayments, the lender may also sell the home used as security. If this is still not enough, the lender may also require you to sell any other assets to meet outstanding debt.
If the parents need to borrow money for another purpose, the property used as the guarantee security cannot be used to secure further finance. It is already ‘tied up’ in the guarantor transaction.
Minimising The Risk
There are ways to minimise the risks. First and foremost, an exit strategy must be clearly outlined and agreed to by all parties. The goal would be to have the child repay as much of the debt as possible over a shorter timeframe so the parents security can be ‘discharged’ from the overall position. This will remove the guarantor portion and ensure the child is now financially standing on their own two feet.
Another way to avoid the risks of being a guarantor is to alternatively provide a monetary gift or private loan. This involves the parents borrowing money against their property in their own name, and then gifting these funds to their child. There are now pretty standard legal agreements that can be put in place to protect these gifted funds.
Another way to avoid the risk is to buy the property jointly between parents and child. This means all names are on the title and a certain percentage entitlement is stated. This does have some negative tax implications that need to be considered.
When it comes to guaranteeing a loan, it’s always sensible to speak to a professional. Every families financial situation is different so the strategy needs to be tailored to ensure all parties understand their risks and best way forward.