The Truth About Bank Of Mum & Dad That Nobody Wants You To Read

Having a guarantor is a great way to help beginners enter the market earlier. In today’s property market, the bank of mum and dad (or guarantors) are one of the many avenues for young property owners entering the property market.

Saving for a 20% deposit for your first home in Sydney and Melbourne can take up to 16.6 years and 14 years respectively, there’s no wonder why it is such a struggle to enter the property market. However, there is an option for parents to assist their child land their first home or first property investment by becoming their guarantor. This will help their child enter the property market earlier than wait for more than 10 years to get their first property. Moreover, it’s better to buy a property now than wait, because house prices today may not be the same in 10 years time.

Guarantors are responsible for the debt owed under a loan provided to another individual or business. If the borrower is unable to meet the repayments, you will be responsible for repaying the debt or the property you have offered as additional security could be sold to repay the part of the debt you guaranteed. 

Discover below if being a guarantor is the right move for you:

WHO CAN BE A GUARANTOR?

Lenders generally require your guarantor to be an immediate family member, such as a parent or partner, but some may also allow others such as a sibling or grandparent, or in some instances a close friend, to be a guarantor. 

Different banks often have different requirements of what makes someone eligible to be your guarantor.  Typically, lenders require guarantors to:

  • Have a good credit score
  • Have equity in a property to be used as security
  • Have a stable income (few lenders accept older people and retirees as guarantors)

According to our Bank of Mum and Dad report 2020, Australian parents are essentially the fifth-biggest home lender in the country and are lending an average of $73,522 to their children. This is the result of a rapid increase in house prices that made it more difficult for younger investors to enter the market for the first time. This drives the parents to put it upon themselves just to help their children get onto the property ladder more easily.

But as popular as it’s become, it requires great commitment and can be pretty risky for parents.

HOW YOU CAN BECOME A GUARANTOR?

You can become a guarantor by reaching out to our bank/lender or mortgage broker and they will clearly map out the steps required for you to become a guarantor. To find out which method is more suitable for your situation, it’s always best to reach out to the team and give you the proper advice before applying for any application. 

WHAT YOU NEED TO CONSIDER BEFORE BECOMING A GUARANTOR?

Before you speak with a mortgage broker or a lender, it’s important to have an understanding of what it means to be eligible as a guarantor. 

  • You must show evidence that you have a stable income which could be your salary or other incomes such as rental 
  • You must show evidence that you have the ability to make repayment if your loan increases 
  • The lender will want to see your balance sheet with assets/liabilities to determine your wealth position.
  • You need to have a property that has a good amount of equity of ideally between $80,000 – $100,000 to cover the initial deposit and other costs if any.

PICTURE THIS SCENARIO:

You child wants to buy a property worth $500,000, but they don’t have that amount of money to put down as a deposit. You as the parent decided to be their guarantor and will assist them with the initial deposit through your own properties equity. 

Let’s say your property is worth $1 million, the lender will allow you to borrow up to 80% of your property value which is $800,000 minus the loan amount owe which in this case is $400,000. That means that you would have access to up to $400,000 of useable equity.

To arrange an initial deposit of $100,000 for your children’s property worth $500,000, you can either gift this $100,000 to them or using your own property to secure against the children’s property. Your children will then response for borrowing the remaining amount and arrange the repayment schedule.

WHAT ARE THE THINGS YOU CAN DO TO PROTECT YOURSELF AS A GUARANTOR?

If you made up your mind to be a guarantor, although there are things to consider, there are also ways on how you can protect your wealth and assets, especially yourself after making the financial decision. You can take out an insurance policy with your children as the ‘life’ insured. This kind of protection is if your family encounters any adversity in life unexpectedly. With your insurance you are protected and secured, you and your child could be saved if suddenly you experience financial hardship such as loss of job, have an accident, or become ill. You and your child should be looking beyond and making sure that if anything were to happen, expenses would be met and houses wouldn’t need to be sold.

4 TIPS FOR PARENTS GOING GUARANTOR

Get legal advice:

Being a guarantor is a big decision, it’s a commitment. Don’t rush into making a decision. Seek out some legal and financial advice, so you’re fully aware of what’s involved and where you put yourself into. Not only is this a good idea for your own preparation, but many lenders will actually require you to do it.

Set A Limitation:

Having an unlimited guarantee may lead you to unexpected trouble. So, limiting your guarantee to a portion of the property price – say 20%. This ensures that your children have enough to avoid lenders’ mortgage insurance, but it also limits the damage done to your own savings and assets if for some reason your child defaults on their loan payments.

Know Your Role:

From the start of the arrangement, you should have a clear understanding of what is your part and it should be discussed how and when your part in the loan end. One way to do it is to plan for your child to refinance and discharge the mortgage on your home once there is enough equity built up in theirs. Doing things in order from the start serves as a reminder to your child that it’s your money and home involved, as well as theirs.

Always consider the downside:

The reality is that we can’t predict the future situation. So, the best thing to do is to be prepared for the chance that your child may be in a position where they can’t make the repayments on their loan. Make sure your insurance is up to date and enough if something unexpected happens. 

WHAT ARE THE ALTERNATIVE WAYS TO HELP YOUR CHILDREN GET THEIR FIRST HOME?

Perhaps you or your would-be guarantor have decided not to enter into a guarantee after all, but they still want to help. Here are some ways they can do so:

1. Gift them the money

Rather than acting as guarantor for your children, consider the possibility of providing money as a gift or an advanced inheritance which could then be put towards a deposit. Or if you’re in the position, buying property on your child’s behalf or as a partner with your child.

2. Help them save

If providing support in the form of a guarantor home loan or via a monetary gift is not an option, consider offering your child the option of moving back home with you and letting them live there for a reduced rent (or rent-free).  Living with your parents can dramatically decrease your overheads and get the deposit together faster.

3. Cash deposit

This move can lower the risk for your parents. A loan against the equity in the parent’s property can be arranged if they’re still working. Retired parents can take out a reverse mortgage. These are more expensive and complex, so should be considered a last resort. 

YOUR COMPLIMENTARY STRATEGY SESSION

If you decided to be your child’s guarantor to have their first home or first investment property – You should be aware of how the guarantor process works as best you can. Reach out to the One Central Property team and we can arrange for a FREE 1-on-1 Complimentary Strategy Session to map out your goals.