How guarantor loans work, plus an alternative option to consider...
Tim Russell | February 28, 2019
With the Sydney market cooling over the last few months, it seems that entry level prices are now at levels where first home buyers are once again interested in entering the market. Latest data from the ABS has revealed that first home buyers now make up 18.3% of the mortgage market, which is the highest level since 2012.
At Multipart Finance, we’re seeing similar results and are dealing with the most first home buyers we’ve ever seen.
Now with first home buyers, particularly in Sydney, having enough money for a deposit is always an issue. And when savings are hard to come by, it means that you either need to pay a considerable LMI fee or you can look to get your parents involved via a guarantor loan to reduce this cost.
We’re getting many of the later in inquires at the moment so I thought I would benefit readers to explain how these loans work and offer an alternative for you to consider if this is a direction you’re considering going down.
GUARANTOR LOANS EXPLAINED
For the record, I’m not the biggest fans of guarantor loans. Saving for your first property is bloody hard work but also one of life’s greatest achievements, certainly from a wealth creation standpoint. It shows dedication and maturity and is a big step towards being a selfsufficient adult.
However, we’re all different and there are many circumstances in which it’s very difficult for a young adult to save for a deposit so each to their own.
In any event, guarantor loans work by having your parents (or a relative) offer their property up as security, in addition to the property you’re looking to purchase.
For example, if you’re looking to purchase a $600,000 2-bedroom unit and your parent’s property is worth $1,200,000 the bank will take security over both properties, effectively increasing the overall asset base to $1,800,000.
Sticking to this example, let’s say that your parents have a loan with CBA for $400,000 and you’ve got absolutely no money for a deposit. Considering purchase costs for the 2bedroom unit at 5% of the value of the property ($30,000), you could technically borrow from the bank the entire purchase price, plus costs ($630,000).
The reason for this is as the bank will be taking security over both properties, they’ll consider their overall risk position as $400,000 (parent’s loan) + $630,000 (your loan) = $1,030,00. Divided by $1,200,000 (parent’s property) + $600,000 (your property) = $1,800,000.
$1,030,000 / $1,800,000 = 57% LVR – a relatively low risk in their point of view.
BANK MARKETING GAMES
The way in which a bank would structure this deal is to split your loan into two:
• Loan 1 - $480,000 (80% of the value of the $600,000 2-bedroom unit)
• Loan 2 - $150,000 (remaining balance)
What they’ll say is that loan 2 will be a ‘limited’ guarantor loan against your parent’s property.
The reason why they say ‘limited’ is because it would appear that you’re really only risking $150,000 instead of the full $630,000 so it’s not that big of a deal for your parents...
However, it should be noted that in the event of a default, the bank would still force you to sell your property to pay out loan 1. From there, you still owe them $150,000 so if your parents can’t come up with the cash to pay out this loan then the bank reserves the right to sell their property as well.
As such, when it comes to ‘limited’ guarantor, just like Public Enemy would say, “don’t believe the hype!”
BANK OPTIONS
It’s important to note that if you want to go down the guarantor route, you’ll most likely have to go with the same lender that your parents are currently with as the bank needs to take security over both properties in order to de-risk their position.
In some cases, if your parents loan is really low, you may have the option for the bank that you approach to take a second mortgage for loan 2 against their property. However, for a second mortgage, the bank that holds the existing one needs to grant permission for the second mortgage to be registered behind them. In most cases the bank that holds the first mortgage wouldn’t allow this as why put themselves at potential risk?
ANOTHER OPTION TO CONSIDER
At the end of the day, a guarantor loan is essentially a private agreement between parents and their children for the parents to take some of the burden of saving a deposit off the table. I’m sure all parents would agree that whilst they’re happy to help their children out, they don’t really want to risk their entire property in doing so.
As such, what I discuss with my clients is for the parents to obtain an equity release loan for loan 2 (remember this is the smaller loan, $150,000 in our earlier example). From their they can either draw up a legal agreement with a solicitor which notes that the children need to pay back this loan with set terms or they can simply have a handshake agreement.
Yes, this loan will be in the parents name and yes, the bank ultimately will hold them responsible for paying them back. However, it creates a clear line in the sand by not linking both properties together and is therefore a lower risk in opinion.
Hopefully this article helps you understand how these loans work and the risks that you need to consider. If you need further information, please do not hesitate to contact me on 0400 530 868 or email tim@multipartfinace.com.au.
Kind regards,
Tim Russell
