October 31, 2017
Are you a first home buyer who has a good income but a low deposit? Or do you hate Lenders Mortgage Insurance (LMI) and want to avoid this additional borrowing charge at all costs? Do your parents want to help you take your first step into the property market but don’t have the cash to assist? If so, you may be interested in a product several lenders currently offer today. It is known by a variety of names but the basic term is a family guarantee.
The easiest way to describe how this product works is that a lender will use the “equity” in your parents’ home to reduce their risk as the lender and thus allow you to borrow without LMI or to borrow while having less of a deposit that a lender would normally require as a minimum, 5% of the proposed purchase price for example.
How is it calculated? As an example, a first home buyer wants to purchase their first owner occupied home for $500k but they only have $15k deposit. The borrower’s parents want to assist but they have little liquid cash. They do however own their home and its’ value is $500k. So while the borrower has the income to service a proposed debt, they don’t meet the minimum 5% lending rule. However if the parents are willing to use their property as security to help the borrower, the borrower can leverage their parents equity. As a basic example, the borrower wants to borrow $485k and they have their property purchased for $500k plus their parents’ property worth $500k, so a total security value of $1m. This brings the loan to value ratio, (LVR) down under 80% which negates the minimum deposit requirement and also brings the LVR under 80% which removes the mortgage insurance premium. There is also the ability to split the loan in 2 so the parents are only guaranteeing a smaller portion of the child’s debt and therefore reducing their own risk.
How can the family guarantee be removed? Either the simple way of the child paying the debt down or by the child’s property growing in value, therefore increasing their equity position and removing the need for the family guarantee. We tend to schedule valuations every 6 months to check the child’s equity position as the main aim is to remove the guarantee as quickly as possible.
Please note that there is a risk to the parents that if the child stops paying their loan for any reason, the lender will expect the guarantor to pay out any portion of the debt after the child’s property is liquidated so these risks need to be discussed and the guarantor needs to be comfortable.
The above is a basic example but it does she the borrowers can enter the market earlier than they may have hoped provided they meet the usual lending and debt servicing rules and have a very generous family member!