What are the risks of going guarantor on a mortgage?
Today, it’s becoming a real struggle to buy a property and get onto the property ladder, but this struggle is even harder for Gen Y first home buyers. This is particularly true in Sydney and Melbourne where the median dwelling price in Sydney at 30 June 2017 according to CoreLogic is now $880,000, and $675,000 in Melbourne.
So how can young first home buyers who want to set up home and take steps to secure their own financial future enter the property market, if they can’t even save up a deposit? With 100% loans no longer available, one of the options which many Gen Y’s are now leaning towards is asking their parents for help.
Parents of Gen Y tend to already own their own home or are still paying down a mortgage. However, their home might have acquired some equity which can be used towards a deposit for their children’s first home.
Instead of saving up a 10 per cent deposit, which in Sydney is more likely around $60,000 plus, parents can go guarantor. The amount of equity required for this does vary per lender though as well as personal circumstances, so it’s best to shop around first.
How does a guarantor loan work?
A guarantor, such as a parent will use some or all of the equity in their own home to be used as additional security for the borrower’s loan (such as their child’s loan). When a guarantor signs the guarantee, this binds the guarantor to this agreement to pay back the entire loan plus any additional fees, charges and interest if the borrower defaults. Defaulting can occur through being made redundant and a loss of income through not being able to work due to health reasons.
What are the benefits of going guarantor?
Acting as guarantor can give your children a way into the property market sooner, without them having to spend more valuable time saving money. The longer they wait to buy, the more likely property prices would have grown in value at a higher rate than wages growth, stopping them from entering the market.
What are the risks of going guarantor?
As well as entering the property market sooner, there are risks associated with going guarantor. We therefore recommend that you speak to an independent and reputable lawyer as well as give this decision some serious thought.
The main risk to consider is if a child defaults on their loan, then the parent would be responsible for payment of this as they are the guarantors. Depending on the type and term of the guarantee, parents could be liable for the whole amount borrowed or the loan amount that was secured by your own property. This means that you may have to sell your own home in order to clear this debt which is very risky especially if you are approaching retirement age and want as little risk as possible. It can also put a strain on family relationships.
You also need to consider that you could also be restricted in borrowing against your own property and assets, meaning that you won’t be able to invest in another property for example, whilst your equity in your home is being used for this guarantee.
Consider an off the plan property purchase
One way to reduce your risk as guarantor is for the borrower to purchase a property off the plan. An off the plan property purchase provides the purchaser with longer settlement times of approximately 12 months or more. This means that no mortgage payments are required until settlement, allowing the purchaser to use this time to save up a deposit. Longer settlement times also means that the property might grow in value. A rising property value could mean that by the time the property is completed, the purchaser now has some equity in the property. This equity along with money saved up during settlement can mean purchasers can release the guarantor immediately or within a year or so, depending on the guarantee.
To reduce the likelihood of the borrower defaulting, there are a number of actions you can take to reduce these risks.
1) Get educated
Before jumping in as a guarantor, it’s important that you fully understand all the implications and responsibilities that are required as a guarantor to ensure there are no hidden surprises. You can speak to your lender or mortgage broker about this in more detail.
2) Purchase sensibly
Ensure that the property the borrower intends to buy sits comfortably within their budget and is a sound investment in a good location close to key amenities. Will they be able to handle the repayments comfortably, particularly if interest rates were to rise? Can they budget accordingly and save responsibly? A property that is way over the borrower’s budget can put more financial stress on them leading to a default on the mortgage. It’s therefore best to speak a property specialist such as iBuyNew and a Mortgage Broker to determine the borrowing capacity.
3) Plan for the future
If the borrower does default on the loan, how will you manage this? Does your financial position allow you to make repayments on the borrower’s behalf or will this cause you financial stress instead? If you are nearing retirement, then this is particularly important to consider as you don’t want to end up in financial stress when you are no longer working.
4) Get insurance
Make sure that both parties have the necessary insurance, which can save you from financial hardship if you lost your job or became ill so couldn’t continue working to pay off the loan.
Before signing as a guarantor, you should both discuss timeframes and how long you should act as guarantor for. Ideally, you should keep this timeframe short to a couple of years, allowing the borrower to pay down the mortgage and potentially see their property grow in value to release the guarantor from this guarantee.
If going guarantor is not for you then there are alternative ways to help your children enter the property market instead.
1) Ask parents to gift you some money
If your parents are in a strong financial position then they might be able to gift you the 10 per cent deposit or provide you with a sum of money towards the deposit, helping you reach your deposit goal sooner.
2) Buy in partnership
Sharing the costs of buying a property with your parents, siblings or partner could also help you reach home ownership sooner. Just keep in mind that you are all on the same path and have a contract written up stating your agreements to avoid family disputes.
3) Allow children to live at home for longer
If you are unable to gift money or act as guarantor, then allowing your children to live at home rent free or lower rents can help them save up a deposit faster for their own home.
Many parents want to help secure their children’s financial futures and going as guarantor could be the right choice for you, as long as you have sufficient funds, have sought legal advice and this agreement does not affect your retirement plans.
Get in touch
To find out more about the benefits and risks of going guarantor or for alternative ways of helping your children enter the property market, why not get in touch with the friendly iBuyNew team who can assist you further.
Give us a call today on 1300 123 463 to speak to one of our expert Property Consultants and view and compare our great range of new property for sale.