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Gone are the days when parents feel obliged to make cash gifts to help their kids get into property. Now with the rise in popularity of family guarantee loans, parents are using their home equity rather than their savings to show they care.
Family guarantee loans, otherwise known as family pledge loans, allow the equity in your parents’ property to be used as security on a home loan. They are not like the traditional guarantees where Mum and Dad would risk their home by taking on the responsibility for their child’s entire loan. Now the security on the new loan can be split and the guarantee limited to a portion, such as 20%.
By limiting the guarantee, your parents aren’t locked into the loan indefinitely. Once your property has increased in value or you have paid off that portion of the loan, your parents’ property is no longer needed as security and they can request to be released.
Case study:
At 26 years old, Julia was saving to buy her first home and having trouble finding one she liked and could afford. She realised she would have to pay Lenders Mortgage Insurance (LMI) because she couldn’t raise enough deposit. LMI is typically charged when the deposit is less than 20% of the property’s purchase price.
That’s when Julia decided to ask her parents for help. Her parents agreed to a family guarantee loan, using the equity in their home as security for 20% of the property. The remaining 80% was covered by the new property Julia was purchasing.
From the $800,000 Julia needed, her parents’ portion amounted to $160,000. It was a relief for her parents to know that if something went wrong, they were only liable to cover the outstanding mortgage up to $160,000.
Her parents were also assured that if Julia lost her job and started having trouble making loan repayments, a solution would be sought. Selling the family home is considered only as a last resort.
Julia was over the moon because she was getting the house she wanted without having to pay LMI. She also had the option to borrow a further 10% to cover the purchasing costs like stamp duty and legal fees.
A year later, Julia received a pay rise and was able to up the repayments on her home loan. It meant that within five years she achieved the required loan to value ratio and was able to release her parents’ guarantee.
The family guarantee loan worked out perfectly for Julia, but not every situation suits this type of loan. For example, if your parents are retired they are less likely to be suitable as a guarantor. Exceptions may be made if they are self-funded with significant assets, but this varies across lenders.
Another obstacle might be if your parents are still paying off their own mortgage. Lenders prefer guarantors to own their home outright but may make an exception if the guarantor’s debt and the guarantee debt doesn’t exceed a certain percentage.
To find out if a family guarantee loan is right for your situation, it’s important you seek the advice of your mortgage broker.
Yellow Brick Road brokers have advised thousands of young Australians in the best way to structure these loans. We’ll explain what the guarantor will be liable for in the event you default on the loan and how to reduce the risk of this happening. You can count on us to help decipher the raft of lender documentation, terms and conditions that you and your parents will need to sign.