Mortgage Experts Blog
Going Guarantor & The Bank of Mum and Dad
Ever wondered what going guarantor means or what a family guarantee is? What about the old bank of Mum and Dad, what’s that about? In this post we explore what these terms mean in the context of how family members (usually parents) can help their kids into the property market.
What does it mean when parents go ‘guarantor’ on their childrens’ home loan? It means parents offer up additional security in the form of an equity guarantee in their property to help their kids secure a loan to buy a home. The younger generation may have secure jobs, sufficient income to service their proposed loan and some savings but not quite enough to get into a home of their own. Sometimes providing a guarantee would be useful simply to help their kids avoid paying mortgage insurance which can be as much as 4% of the loan amount.
This type of family guarantee does not mean that parents are responsible for paying their kids’ loan. It means they are putting a property up as security for the loan so in a worst-case default scenario it means the guarantors pledged property could be sold. Of course, the lender would pursue the sale of the childrens’ property first and the guarantee is a limited guarantee meaning only the amount of the guarantee is at risk. If the parents had other assets they could use those to pay out their guarantee or part thereof to avoid the sale of their property.
Typical Guarantee Example
Let’s say a young couple is looking to buy their first home with the following details.
- Purchase Price / Value of the property $1,000,000.
- Costs such as stamp duty and legal fees $45,000.
- Total savings of $85,000.
- Loan required $960,000 ($1M + $45K - $85K).
- Loan to value ratio (LVR) 96%.
As they would need a loan of $960,000 the LVR would be 96% meaning that they would not qualify for a loan (maximum is generally 90% or 95%). Not only are they short on the deposit they also haven’t got funds to cover the mortgage insurance which would be another $35,000 - $40,000 if looking to borrow the maximum LVR allowed.
In step the parents, who have equity in their own property. They can offer the lender a limited guarantee on their property providing equity sufficient to ensure the lender has 20% equity buffer on the loan required. In this case $200,000 in additional equity would be required to make the LVR 80%. ($960,000 loan / $1,200,000 in equity = 80%). The $1.2M is the combined values of the property being purchased and the guarantee amount needed on the parents’ property.
How do you release a guarantee?
Down the track the ‘guarantee’ can be lifted off the parents’ property when the property that was purchased has the required 20% equity buffer on its own - or put another way, the current loan amount divided by the current property value is less than 80%. This is usually initiated when the price goes up enough to allow a re-valuation.
The Bank of Mum and Dad
What about receiving a cash gift or loan from your parents to get to your deposit goals faster? This type of help has been nicknamed the ‘bank of mum and dad’ and is probably the number one way that parents assist their children to get into the property market.
The big plus with this is of course the amount borrowed from the bank is less than with a straight up family guarantee option.
One issue that can arise when gifting funds is the bank/lender won’t see these gifted funds as “genuine savings”, meaning that even though you may have the required funds available for a deposit you may still need proof that you have accumulated some genuine savings yourself. This goes to your ability to repay a loan and general financial responsibility. Generally, proof that you have saved 5% of the proposed purchase price over time is required when borrowing 90% or more of the property value. Sometimes you can show a rental history in lieu of proving your saving history. This of course doesn’t negate the need for the actual deposit funds being available.
Another issue is when the funds from family are a “loan” and not a gift per se. This is a complex area, and many lenders don’t like the funds being a “loan” because it can impact the borrower’s future capacity to repay the proposed bank loan. There is however usually a solution to keep all parties happy whether that be a formal loan agreement with no set repayments and no set interest rate etc or perhaps parents loaning the funds before the application is made (this is assuming no repayments are payable).
At the end of the day is having a guarantor a better option than being given some extra cash to help with a deposit? Every family circumstance is going to be different. It might suit a particular family to give a gift with the big plus being they have limited responsibility for the loan ongoing. The alternative if they go guarantor carries more risk but can save the borrower a lot in avoiding mortgage insurance and better interest rates. So you would need to weigh up these pros and cons with your family to see what suits you all best.
If you have been thinking about going guarantor for your kids, gifting them a deposit or you are thinking of asking your parents for help then you should contact our team to crunch the numbers and strategise with you to see what’s possible.