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Rising house prices are making it increasingly difficult to enter the market. Parents who guarantee their children’s loans can help, but it is important to understand how this can impact the parents’ retirement or investment plans.
Being a guarantor generally means using the equity in your own property as security for your child’s home loan. It can help a first-home buyer to secure finance for a property they can afford but may not have a large enough deposit for, and to avoid the added cost of lenders mortgage insurance.
There are other advantages as well. By guaranteeing a loan, you’re helping your child enter the property market sooner. Also, your child may be able to buy in a more desirable location and a home that better suits their needs or needs less spent on maintenance. If they did it on their own, they may need to go further out of the city or perhaps settle for fewer bedrooms.
You may want to help your child but it’s important you don’t go into the transaction blindly.
The main risk of guaranteeing the loan is that, depending on the structure of the guarantee, you will be liable should your child default on the payments, either by taking over the repayment schedule or handing over a full repayment.
If you can’t make the payments, the lender may sell the home used as security. If this is still not enough, the lender may also require you to sell assets to meet outstanding debt.
Another major risk is a bad credit rating if a default occurs on the home loan.
And also please note, if you need to borrow money for another purpose, your property cannot be used. If you want to buy an investment property, you can’t use the equity in your own home because it’s already tied up in the child’s loan.
Minimising the risk
There are ways to minimise the risks. The most common is using a monetary gift or private loan. This involves borrowing money against your property in your name, and then gifting it to your child. You should have a legal agreement in place for the loan you give.
Another way to avoid the risk is to buy the property jointly with your child. This means your name is on the title and you have a certain percentage entitlement.
Also some Lenders may permit you to only Guarantee the 20% of the property needed for the Deposit and to avoid Mortgage Insurance. As the value of the property rises or the Loan is paid down, you can be released from the guarantee. This may even be kept as a separate loan to limit the amount of your exposure to the guarantee and can be paid out earlier to clear the guarantee if necesary.
When it comes to guaranteeing a loan, it’s always sensible to speak to a professional. You should also consider asking a legal professional to draw up a formal loan document outlining all conditions of the loan, interest rate and expected repayments.
Finally, outline an exit strategy. Financial situations change and, as the loan decreases with repayments, there may be an opportunity for you to withdraw your support to free up your assets without impacting your child’s loan.
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