Rising house prices are making it increasingly difficult to enter the market. Parents who guarantee their children’s loans can help, but it is important to understand how this can impact the parents’ financial future.
Being a guarantor generally means using the equity in your own property as security for your 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 plus you can avoid the added cost of lenders mortgage insurance.
There are other advantages as well helping your child enter the property market sooner. Your child may be able to buy in a more desirable location and a home that better suits their needs. Should they do it on their own, they may need to go further out of the city or perhaps settle for a smaller block or different property type.
You may want to help your child but it’s important you don’t go into the transaction without doing your homework.
The main risk of guaranteeing the loan is that, depending on the structure of the guarantee, you could be liable should your child default on the payments, either by taking over the repayment schedule or handing over a full repayment.
If you can’t make the payments, the lender may sell the home used as security. If this is still not enough, the lender may also require you (i.e. the guarantor) to sell assets to meet outstanding debt.
Another major risk is a bad credit rating if default occurs.
Plus, if you need to borrow money for another purpose, your property cannot be used. If you want to buy an investment property, you can’t use the equity in your home because it’s already tied up in the child’s loan.
Minimising the risk
There are ways to minimise the risks. The most common is using a monetary gift or private loan. This involves borrowing money against your property in your name, and then gifting it to your child. You should seek legal advice or have a legal agreement in place.
Another way to avoid the risk is to buy the property jointly with your child. This means your name is on the title and you have a certain percentage entitlement. But note that should you wish to be removed from title that there are stamp duty and capital gains tax liabilities that need to be considered which you may wish to see legal and financial advice about.
When it comes to guaranteeing a loan, it’s always sensible to speak to a professional. You should also consider asking a legal professional to draw up a formal loan document outlining all conditions of the loan, interest rate and expected repayments.
Finally, ensure there is an exit strategy. Financial situations change and, as the loan decreases with repayments, there may be an opportunity for you to withdraw your support to free up your assets without impacting your child’s loan.
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