Average house prices in Australia fell by 0.5 per cent in the December quarter with Sydney suffering the largest decline of 3.1 per cent. So what does this mean for parents who have, or are thinking about guaranteeing their children’s home loans?
With a peaking property market and deteriorating housing affordability, Ramon Mitchell, Director of Acquisitions at Performance Property Advisory, has noticed an increasing trend of parents helping their children enter the property market via family guarantees. “We’re particularly noticing an increase in younger, first-home buyers who are making the most of this to get on to the increasingly difficult to reach first rung of the property ladder” says Mitchell.
Under normal lending circumstances, where a borrower does not have enough savings to meet a 20 per cent deposit plus stamp duty, the bank will either decline the loan or impose Lenders Mortgage Insurance, which can cost thousands of dollars. Sydney mortgage broker Elaine Lam explains “a family guarantee can be a useful tool that allows borrowers to finance property with little or no deposit, where their parents are willing to assist by providing a limited security guarantee secured against their home, an investment property or another financial assets such as a term deposit”.
But the procedure can be a risky strategy as it allows borrowers to buy property with no cash and no evidence of genuine savings, as long as the bank is satisfied the borrower can meet the ongoing loan repayments, says Lam. In the event the borrower defaults on the loan, the bank will come after the parents for any losses and costs that the bank incurs.
The benefit of a family guarantee lie solely with the borrower, not the guarantor, says Joseph Alam, head of retail business at finance broker Lendfin. “It can take upwards of 10 years to save for a deposit in some areas of Australia and during this time the property market is likely to have lifted substantially, meaning the borrower keeps chasing ever shifting goalposts”.
Mitchell has also witnessed the use of family guarantees to help children “buy into aspirational suburbs and avoid having to buy at a lower price then sell and upgrade a few years later, triggering a round of real estate agent fees, stamp duty and legal costs”.
Sydney couple Daniel and Alyssa James recently bought a house-and-land package in Sydney’s northwest with the help of a family guarantee from Alyssa’s parent. The couple noted that “the family guarantee meant that we could upgrade homes sooner and allow us to be closer to Sydney then we currently are”.
For parents who already have a guarantee in place, Alam suggests a few pointers:
● The property is revalued every two years. If there is enough equity, the bank will release the parents from any liability of the original loan.
● If there isn’t enough equity to release the parents, Alam advises the parents and children have a frank talk on how long the guarantee is to remain in place and agree on an increased loan repayment schedule so that the children can reduce the debt to the point where the parents can exit the guarantee arrangement with the bank.
● For parents looking to provide a family guarantee to their children for a property purchase, Lam advises that each party understand their obligations under the contract, and in particular, the parents should seek legal advice on the repercussions if the children’s marriage dissolves.
Northshore Property Sales principal Trevor Chan recommends “that an agreement should be drawn up between the parents and children to handle any potential situations that could arise in the future to avoid future disputes”. Alam of Lendfin adds that “parents should speak with their children about the large responsibilities involved and ask how stable their employment situation is.”
Not all banks allow parental guarantees, while others have strict rules. Lam recommends that prospective borrowers thinking about a family guarantee first seek advice from a mortgage broker to find out their options and then discuss the potential scenarios with their parents.
James Gerrard is the principal and director of independently owned Sydney financial planning firm FinancialAdvisor.com.au