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With Australian property market prices witnessing some of the sharpest price rises across the globe, the government and the mortgage industry have been looking at means and ways to get first home buyers onto the property ladder. Amongst the many schemes and incentives, the parental guarantor scheme is gaining popularity. Here’ a quick guide on how it works.
What is it?
Under Parental Guarantee schemes, lenders allow borrowers to use equity from property owned by their parent or parents to serve as security or collateral for a home loan. In other words, a parent or both parents become a guarantor for the borrower’s home loan. This means that in case the borrower is unable to keep up repayments, the lender reaches out to the guarantor for payments or takes control of the equity that has been used as collateral.
When should this be considered?
This scheme is typically useful for borrowers who don’t have enough saved up for a home loan deposit. Home loan rates are the best with an 80% Loan Value Ratio (LVR) or when the borrower has 20% of the property value as deposit. With the parental guarantee scheme, a borrower can gain access to these rates without having the entire 20% deposit.
Another approach to securing a home loan with less than 20% deposit is Lender’s Mortgage Insurance (LMI). This insurance protects the lender against repayment defaults. While the government does offer LMI for a first home buyer, there are cases where borrowers aren’t eligible and opting for LMI can significantly increase the cost of the home loan.
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How does this work?
Let us assume that a borrower is looking at purchasing a $500,000 property but does not have the $100,000 deposit (20% property cost). Most lenders will offer a home loan with a 5% deposit of $25,000 but will do so with an LMI that will cost around $16,500. By using the equity of $75000 from a parental property, a borrower can make up for 20% deposit without LMI.
Benefits to a borrower
Opting for parental guarantor schemes allows borrowers to access the property market sooner without having to wait years to save for a deposit. It will enable a borrower to obtain a 95% LVR property without LMI. Finally, it allows borrowers to seek help from parents without actual financial assistance. Though parents act as guarantors, the responsibility of paying the loan lies with the borrower.
Things for Parent guarantors to consider
A lender reaches out to the guarantors only in case a borrower is not able to keep up with repayments.
Before opting to become a guarantor, it is vital to consider the following:
- The probability of a payment default
- Impact of financial wellbeing in case repayments need to be paid by guarantor
- Possibility of lender owning equity put as collateral
It is, therefore, best to seek professional advice to understand how to make the best of a parental guarantee scheme as each borrower’s circumstances are unique.
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