What is Parental Guarantee?
A Parental Guarantee Loan allows parents to help their children secure a home loan by providing additional security or income support. This can enable their kids, who could be first-time buyers to enter the property market sooner, and avoid paying Lenders Mortgage Insurance (LMI) that often can be tens out thousands of dollars. Listed below are two key type of Guarantees available:
Security Guarantee
A Security Guarantee involves parents using the equity in any of their property as collateral for part of their child’s home loan. Instead of providing cash, they allow their property to be used as additional security. Some banks will also accept Term Deposit funds as security from the parents. This can help borrowers secure a loan with a smaller or no deposit while avoiding LMI. The kids are still required to have enough income to borrow the full amount they need from the bank.
Example: If a homebuyer has only a 5% deposit, their parents can offer a limited guarantee on 15% of the loan, allowing the borrower to reach the 20% threshold required to avoid LMI. There are some lenders that can go up to 110% of the property price to cover all costs associated with the purchase (such as stamp duty and settlement costs)
Servicing Guarantee
A Servicing Guarantee is when parents contribute towards the borrower’s loan repayments by using their income. This can help in cases where the borrower’s income is insufficient to meet the bank’s serviceability requirements. In such scenarios, the parent becomes a co-borrower or guarantor on the loan. The bank will need income evidence from the parents to check that are in a good financial position to afford not only the portion they are guaranteeing but the full loan amount. This option is mainly suitable for parents with high incomes and some banks also have asset test as well as they would only offer this option to high net worth parents.
Example: A borrower with a lower income may not qualify for the required loan amount, but if their parents have a strong income, they can guarantee part of the repayments to help the borrower secure the loan. The parents are recommended to fully understand their legal obligations in their arrangement as they will be liable to pay the monthly loan repayments in case the kids defaulted for any reason.
- Avoids LMI: By offering additional security to the bank for the loan, borrowers can avoid paying Lenders Mortgage Insurance, which can save tens of thousands of dollars in many cases
- Reduces Deposit Requirement: First-time buyers can enter the market sooner with a lower deposit or no deposit as some lenders can also go up to 110% of the property price to include all associated costs.
- Improves Borrowing Capacity: Parents' support can enhance serviceability, helping kids qualify for higher loan amounts. This can often be helpful for kids to buy in locations closer to the parents, which may not be affordable with just their income.
- Better Interest Rates: A stronger financial position in terms of security or income available, may allow borrowers to access more competitive home loan interest rates.
Benefits for Parental Guarantee?
Risks of Parental Guarantee?
While parental guarantees offer great benefits, they also come with risks that both parents and borrowers should consider:
- Risk to Parents’ Assets: If the borrower defaults, the guarantor’s property (or income) may be at risk. So parents personal circumstances should be carefully considered before getting into this arrangement. Especially if the parents are retired and they are using their only residential security to offer guarantee, they need to mindful that the bank can come after that asset in case the kids default on the loan.
- Limited Borrowing Capacity for Parents: A guarantee can reduce the parents’ ability to borrow for their own needs in the future. The Guarantee amount will reflect on the Parent's credit report and some lenders may put the full liability against them if they go for any loans in the future.
- Financial Strain: If parents have to cover repayments due to kids not able to meet the obligations for any reason, it may impact their financial stability, especially in retirement.
- Potential Family Conflicts: Financial arrangements between family members can sometimes lead to disputes.
Recommended Due Dilligance
Before proceeding with a parental guarantee, consider the following:
- Understand the Guarantee Type: Ensure both parties fully understand the type and extent of the guarantee being offered.
- Seek Legal and Financial Advice: Parents should obtain independent legal and financial advice before signing any guarantee.
- Consider a Limited Guarantee: Instead of guaranteeing the entire loan, parents can opt for a limited guarantee covering just the necessary portion to avoid LMI.
- Discuss an Exit Plan: Plan for how the guarantee will be removed in the future, such as when the borrower builds sufficient equity.
- Check Loan Terms: Some lenders offer flexible options that allow for early release of the guarantee.
- Engage an experienced Mortgage Broker who can find the most suitable lending product for your scenario. The policy amongst different lenders varies and a good mortgage broker can help you understand difference in simple language to make an informed decision. At WizWealth Finance we have a Parental Guarantee specialist who can guide you further if you are interested.
