Demystifying the parental guarantee option for first home buyers.
With Australian property prices rising and significant ongoing increases to the cost of living, it’s little wonder that many potential first home buyers struggle to pay rent as well as saving a deposit on a new home and as such lose faith in being able to achieve the Australian dream of home ownership. First home buyers are starting to ask, "can my parents be a guarantor for my mortgage?"
As it so happens, there is a little known and often misunderstood policy offered by a number of home loan lenders that answers this very question – it’s called Parental Guarantee or Family Pledge.
The Parental Guarantee/ Family Pledge policy works broadly as follows:
• Parents or other willing family members have a home or investment property and are prepared to offer one of their property assets as security in order to provide a limited guarantee for up to 20% of the purchase price of son/daughters property plus costs such as stamp duty and legals.
• Son or daughter can then borrow up to 100% of the purchase price of the property plus stamp duty and legal costs if applicable. This would allow them to avoid having to save a substantial deposit as well as avoid paying a significant Lenders Mortgage Insurance (LMI) premium.
• The limited guarantee can be removed when the borrower's loan becomes less than, or equal to, 80% of the value of the property – by way of increased value in the property and reduction in loan. The loan can sometimes even be split 80/20 with 80% on interest only and 20% on principal and interest with an aggressive repayment plan set up to pay down the 20% amount guaranteed in order to remove the guarantee in a timely manner.
• Parents need to confirm that they have sought independent legal advice on the guarantee arrangement in order that they fully understand the parameters of offering their guarantee (once the loan has been approved and loan contracts are ready to be signed by the borrower - with separate contracts available for the guarantor).
• If parents offer a property for the guarantee and that property has a mortgage against it, the new loan will typically need to be with the same bank....or be refinanced to the bank the borrower is applying with. Also, the bank will not lend to more than 70% of the value of parents property when amount of existing mortgage and guarantee are combined.
• Parents should be aware that the security they offer, whether that is an investment property or their home, would be at risk if the borrowers loan went into default for any reason.
• Some lenders require the guarantor to be able to display ability to repay the guarantee amount (so that in the event the loan goes into default and the guarantee is called upon by the bank, the guarantor has ability to make repayments instead of having their property repossessed).
So now you know the basics, it's important to have a very frank and honest chat with your parents before you go down this path. You do not want to risk their house and you want to be clear that you have enough time to build up at least 20% equity in your new home before they need to remove themselves as guarantor.
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About the author: Phil Riches is CEO & Director of Model Mortgages Pty Ltd, with over 15 years commercial and residential lending experience, currently as a licensed finance broker, with relevant background in various roles with major bank and non-bank lenders. www.financeonthecoast.com.au