Home prices in Australia have reached an all-time high, making it increasingly difficult for first-time buyers to get a foothold in the property market. By March 2024, the average price of a home in Victoria was $928,500, meaning that a buyer would need to have a hefty cash amount of $185,700 to pay a 20% deposit.
In this situation, more and more parents or other eligible family or friends are assisting young people in purchasing a property, often by providing guarantees for a home loan to be taken out by the buyer. The equity held in a parent’s home forms part of the security provided by a guarantor for the child’s home loan. However, while it can be great for young borrowers to have parents willing to provide a guarantee so that a child can buy a property, guarantees are often not so advantageous for the parent.
What is a home loan guarantee?
When a parent or another person enters into a home loan guarantee with a lender (such as a bank), the parent-guarantor agrees to perform the obligations of the home buyer (or child) under the home loan contract entered into between the child and the lender. This means that if the child defaults on the loan conditions (for example, by failing to pay the home loan instalments), the lender will seek that the guarantor pay the debt owing under the loan.
The lender may seize the assets of the guarantor (such as their home) to pay the debt owed by the borrower. If those assets are not sufficient to discharge the debt in full, the lender may seek to have the guarantor declared bankrupt.
What are the benefits of a home loan guarantee?
Guarantees may greatly assist someone in buying a property. If a guarantee is provided, it is more likely that a home loan may be approved by a lender and may be in a lower amount. Also, a guarantee may mean that a purchaser will not have to pay for Lender’s Mortgage Insurance (LMI), which is required if a buyer does not have a deposit of 20% or more of the purchase price. LMI can add thousands of dollars to the cost of buying a property.
What are the risks of a home loan guarantee?
While a guarantee may benefit the home buyer, it can expose the guarantor to many risks.
Financial risks:
- If your child defaults on the loan, you will be liable to pay the outstanding amount you have guaranteed.
- This may also affect your credit rating, making it harder for you to borrow in the future.
- The lender may take legal action against you to recover the debt owed, which may result in heavy legal costs.
- You may have to sell assets (including your home) to pay the amount owed under the loan.
- Property market fluctuations could result in a decrease in the property’s value – you may still be liable for the original loan amount, which may exceed the property’s worth.
- Inheritance issues – if a parent/guarantor dies while the guarantee is still in place, the liability may lessen the value of the parent’s estate, leading to potential legal battles over the estate.
Emotional risks:
- If your child is unable to meet the home loan repayments, this may place considerable strain on family relationships.
What are some alternatives to home loan guarantees?
Some other options available to parents and others who may want to help a young person buy a home include:
- Allowing your child to live with you rent-free or at a low rent so that they can save a deposit.
- Gifting the money to your child.
- Buying a property in your name alone for your child to live in.
- Buying a property in both your name and your child’s name.
- The First Home Loan Deposit Scheme (FHLDS) – first-time buyers with at least a 5% deposit do not need to pay LMI. Instead, the government will act as the guarantor for the remaining amount of the deposit.
What should you do before providing a home loan guarantee?
- Set a limit to the amount of the guarantee provided – limit your guarantee to a portion of the purchase price of the property (for example, 20%). This is enough to ensure that your child will not have to pay LMI and also means that your liability is limited to an amount less than the full price of the property if your child defaults on the loan repayments.
- Plan for an exit – for example, you could enter into a written agreement with your child stating that they will refinance the loan when a certain amount of equity in the property has accrued.
- Get good advice from a lawyer and an accountant. Contact us for assistance.
Please note, the above contains very general information on the subject matter and should not be regarded as legal advice. Legal advice should always be sought as to your specific circumstances.
