Soaring rents are motivating more young people to become first home buyers, with many seeking help from “the bank of mum and dad,” but everyone should know the commitment they are making before proceeding. Most parents want to be in the position to help their children achieve this dream, but they must go into the agreement with their eyes open.
What are the pros and cons of the bank or mum and dad?
According to recent research, about 40% of 25- to 34-year-olds expect to call on the ‘bank of mum and dad’ to achieve home ownership, with many likely to utilise a parental or family guarantee. However, guarantees come with potential positives and negatives for both parties, which means everyone needs to understand the commitment they are undertaking.
Parental or family guarantees have been increasing in popularity over the years given the high price of property but also the equity that many long-term property owner “mums and dads” have in their homes. A parental or family guarantee is when a parent or family member uses the equity in their home as security against a loan taken out by their child or family member.
For example, if a mum or dad has $500,000 equity in their home, this equity can be used as security against their child’s mortgage. There are pros and cons with using this mortgage facility, which I always recommend everyone understands thoroughly before proceeding.
- The borrower doesn’t need as big a deposit as they are using their parents or family member’s property as security.
- A parental or family guarantee can potentially mean avoiding or reducing the cost of Lenders Mortgage Insurance.
- There is no cost to the guarantor – as long as the mortgagor always makes their mortgage repayments.
- Once the mortgagor has built up enough equity in their home or has paid off enough of the mortgage to get to an 80 per cent Loan to Value Ratio (LVR), the guarantor can be released from the agreement.
- If the mortgagor defaults on their mortgage, the guarantor – parents or family member – is liable for the entire sum that they’ve promised to cover which is the amount over the 80 per cent LVR.
- The guarantor’s ability to take on further loans for themselves or for guaranteeing others is diminished during the guarantee period.
The guarantor may be putting their own home at risk if the mortgagor defaults on their home loan and they are unable to repay the initial sum guaranteed.
Louisa Sanghera is 2021 Australian Mortgage Awards Independent Broker of the Year and Zippy Financial Director and Principal Broker.