Meet Josh: Josh is an 18 year old living at home with Mum and Dad. He is looking to get into the property market and purchase an investment property in Western Sydney that he may, one day, decide to live in. He has looked around and completed some research to discover that the average price of properties in most suburbs is $600,000.
After doing the sums, Josh has worked out that he will need to save a whopping $120,000 to get the 20% deposit he needs in order to avoid paying for Lenders Mortgage Insurance (LMI).
Josh is shocked at this figure. He has saved $30,000 so far, since he started working, and that has taken him nearly 2 years!!
After surfing the world wide web to find a solution to his problem, he comes across an idea, known as a GUARANTEE, which many lenders offer today.
The idea of a guarantee or what it means to be a guarantor can be rather difficult to wrap one’s head around. Yet they are becoming more and more prevalent in today’s day and age given how difficult it is to get into the market today – especially for younger people like Josh with whom, saving that 20% deposit could take years and the ideal of owning your own home becomes an endless, never ending chase.
So, let’s try and make it a little more transparent, shall we?
Being a guarantor, applying for a guarantee or attaining a “Family Pledge” are all different ways of saying the same thing.
The accessing of equity in an existing property for the use of attaining a new home loan is known as a SECURITY GUARANTEE – where the security is the guarantor’s property.
Let’s look at Josh’s scenario above and break down what it means for him to have the assistance of a guarantor…
For Josh, attaining a guarantee or family pledge would mean that his parents, after careful consideration, would allow the bank to hold title of their property and use a portion of the equity in their property to bridge the gap between Josh’s current savings of $30,000 (5% of the security value / purchase price) and the amount required to avoid Lenders Mortgage Insurance – the 20% deposit.
In this scenario, Josh’s parents would pledge $120,000 from the equity in their home as security for Josh’s new home loan.
If you add the parent’s $120,000 (equity) to Josh’s savings of $30,000, he would have a 20% deposit ($120,000) plus an extra $30,000 to cover the loan costs i.e. Stamp Duty, Legal Costs, Application Fees and Settlement Fees.
How lucky is Josh right now? It all sounds fabulous!
So, why wouldn’t all parents do this for their children?!
Being a guarantor is not a decision to be taken lightly. There are great advantages to being one but there are also risks involved which should be reviewed, discussed and thought out before making the decision to go ahead.
Let’s consider the pros and cons:
- Helping a family member (or friend depending on the lender) get into a home they want much sooner.
- Avoid paying Lenders Mortgage Insurance (LMI).
- Maximise your potential borrowings so you get the house you want.
- The guarantee can be released once the loan on the property reaches the appropriate Loan to Value Ratio (LVR), which in Josh’s case is reducing the loan down to $480,000 or 80% of $600,000.
- Many lenders don’t charge extra fees for setting up a guarantee.
- If the asset depreciates and repayments can’t be made, it may be necessary to sell the security that provided the equity for the guarantee.
- If you provide a guarantee on a home loan, it could affect your ability to take your own loan out as the guarantee will reduce your ability to service new debt.
- If something goes wrong, your own home may be at risk and, you may become responsible for making the repayments on behalf of the mortgagor.
- The guarantor usually has no ownership or right to property being purchased. Thus, there is no financial gain.
Other Items to consider:
- Do not allow yourself to be pressured into going guarantor.
- Seek independent advice.
- Get a second opinion.
- Work on worst case scenarios.
- Be 100% confident that the person with whom you are assisting with a family pledge / guarantee can, and will, pay it back. Is the guarantee you are providing allowing the person to purchase beyond their means?
- There are other options, such as paying for Lenders Mortgage Insurance (LMI) or sourcing a cheaper property
- Would you be more comfortable providing a non-refundable gift that could be used as a deposit?
- Not all banks offer the same features in their version of a Guarantee. Therefore, it is important that you consult a trusted broker to ensure you are partnered with the best bank that meets your specific requirements.
Whilst helping a loved one purchase a property they really want can be extremely gratifying, it is essential that you consider all the factors involved before signing on the dotted line!
I would love to assist you further with any questions you may have about being a guarantor. For more information, contact me on 0406 625 926 or email me with your questions.