Guaranteeing your child’s loan

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

The Risks

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.


Offset accounts: should you have one?

A common request from borrowers is that they ‘need’ an offset account. When asked to explain why, it’s amazing how many people say “my friend has one and they love it, so I thought I should have one too”. They suit most borrowers, but to know if one will suit you, let’s first understand exactly what an offset account enables you to do.

How do they work?

An offset account gives you the freedom to “park” your own funds (savings) in an account that is linked to your mortgage. The funds that are parked in there offset the interest charged on the total loan. These funds are freely available for you to use for your everyday transactions just in the same way you would use funds from a savings account.

In numerical terms, if you have a $100,000 mortgage at 5% interest rate with no offset account, your annual interest charge would be $5,000. If you had the exact same loan with $10,000 in your offset account, your annual interest charge would be $4,500.

The way to think of it is simple. The funds in your offset account don’t earn you interest, rather they offset the interest charged. When thinking about the opportunity cost, if the interest rate of your savings account is less than the interest rate of your home loan, then your funds will produce a more positive effect when held in your offset account.

Are they right for you?

For other people with owner occupied home loans, convenience and interest savings are the major benefits. The savings in interest are the same whether you use an offset or whether you pay the funds into the loan itself… but… having the funds in a separate account can provide convenience and flexibility especially when it facilitate transactions just like any other savings account. Your cash can be saving you interest right up to the time it is needed.

For investors, if you are claiming a tax deduction on the interest charged on your loan, then most accountants will advise you not to deposit your own funds into your offset account and draw them out. In the wash up, it is usually more beneficial to keep your investment debt high and personal debt low.

So, should you have an offset account? One of the great things about an offset account is that it can be beneficial no matter if you are a saver or spender. For a spender, you can have your salary paid directly into your offset account as the money will have an immediate impact on the amount of interest you pay.

If you are a saver, you may find that an offset account is more beneficial than a savings account as you may earn less interest on a savings account than what you would save on your home loan.

What’s on offer?

The majority of lenders offer products that can have an offset account attached to the loan. For this, some will charge a slightly higher interest rate, however some simple sums can see if the extra cost is worth it.

When researching and comparing home loans, it’s worth looking at any possible fees or restrictions to moving money around that may be associated with the offset account. Some lenders may have minimum transaction amounts and withdrawal fees if you decide to redraw money from your offset account and these fees could end up costing you more than the interest you would save.

Before making any decisions, you will need to carefully research your options and speak with your broker and weigh up their advice as to what will work for you.


What is the real cost of your daily coffee?

Having the financial commitment of a mortgage really makes you think about the value of your money. It forces you to watch your dollars a lot closer and brings into question the opportunity cost of doing one thing over another. It is surprising to see the impact that small financial habits, like your morning coffee, make over the long term.

If you’re a one-a-day coffee drinker, that is an annual cost of around $1,300. On a $500k mortgage over a 30 year period, if you were to forgo your coffee and put these funds towards paying back your loan, this would cut 2 years and 4 months off the length of your mortgage and save $30k+ of interest repayments.

As a Melbourne based broker, I know telling clients to give up coffee isn’t going to win me many friends… but… its more about the power of your dollars over the longer term. Do you have a regular financial outgoing that you could reduce or get rid of that could assist you in repaying your mortgage quicker?

  • Bring your lunch from home
  • Cancel your gym membership that you never use
  • Shop around for a cheaper health/life/car insurance product
  • Go out drinking only once per weekend
  • Book smarter holiday options
  • Do you really need that expensive car with large monthly repayments?

It may not be one thing in particular but the sum of multiple ‘sacrifices’ that can create financial gain in the long term.

Maybe you will think twice before ordering that second coffee for the day…