If your children or grandchildren are struggling to save the large deposits needed to buy a home these days, you may be wondering how you can help financially support them in meeting this goal. Becoming a guarantor might seem like the right answer - but, while it might seem like a great idea to step in and help, it pays to be across all of the pros and cons involved.
Here are some of the major things to consider.
How does it work?
Going ‘guarantor’ is commonly known as the act of securing the purchase of a loved one’s home using the equity in a property you own.
For most lenders, the ideal borrower is one that has saved a minimum of 20% of the purchase price of their desired property. But, for many first home buyers, this can seem like an impossible feat.
Borrowers who do not have a 20% deposit saved have a couple of avenues they can take. Other than having a family member guaranteeing their loan, they can opt to pay Lender’s Mortgage Insurance (LMI). This insurance covers the lender in the event that a borrower defaults on their loan. The downside to LMI is that it can add thousands of dollars to what is already a significant debt.
As a guarantor, you allow the equity in your own property to be used as additional security for your loved one’s loan. However the borrower is still the one responsible for making the repayments on the mortgage.
Guarantors do not have to secure the entire loan, however. There is an option to guarantee only an agreed portion of your loved one’s home loan for a designated period of time. This means you will not be financially liable for the life of the loan.
Why would I do it?
In Australia, property has proven to be a safe long-term investment strategy. A report by the Grattan Institute found that house prices have more than doubled in real terms over the past 20 years1. While going guarantor is not without risk, helping a loved one achieve their property ownership dreams, sooner rather than later, can be an incredibly rewarding experience.
What are the risks involved if I guarantee my child’s/grandchild’s loan?
Going guarantor can have a lasting impact on your credit score and future borrowing power so you will want to be prepared for any and all risks. As a guarantor, you are potentially liable for the home loan. You will need to seriously consider if you are in the financial position to pay the loan in the worst case scenario, keeping in mind that if your loved one defaults, you would be legally responsible for the repayments. Not only can this have a significant impact on your own financial position, it can also have a detrimental effect on your credit score.
If you are considering guaranteeing a loved one’s loan, it’s critical you seek legal and financial advice. Your local mortgage broker can help you determine whether going guarantor is a good option for you and your loved ones and discuss which options you could consider.
1. Grattan Institute, Housing Affordability Re-imagining the Australian Dream March 2018