"The bank of mum and dad" is a well-worn phrase we've all heard of when it comes to parents supporting children who are buying their first home. But is it really wise - for both parties involved?
Louisa Sanghera is the financial director and principal broker of mortgage broker, Zippy. She said that parental or family guarantees have been increasing in popularity over the years given the high price of property but also the equity that many long-term property owner "mums and dads" have in their homes.
"In essence, a parental or family guarantee is when a parent or family member uses the equity in their home as security against a loan taken out by their child or family member. For example, if a mum or dad has $500,000 equity in their home, this equity can be used as security against their child's mortgage," she said.
"Of course, there are pros and cons with using this mortgage facility, which I always recommend everyone understands thoroughly before proceeding with this option."
Let's start with the pros, which admittedly favour the children.
First up, the borrower doesn't need as big a deposit as they are using their parents or family member's property as security.
Also, the chance of the borrower needing lenders mortgage insurance can be eliminated, or reduced.
There is no cost to the guarantor, as long as the mortgagor always makes their mortgage repayments.
Finally, once the mortgagor has built up enough equity in their home or has paid off enough of the mortgage to get to an 80 per cent Loan to Value Ratio (LVR), the guarantor can come off the agreement.
Now, here are the downsides, which affect parents.
If the mortgagor (in this case, the child) defaults on their mortgage, the guarantor - parents or family member - is liable for the entire sum that they've promised to cover, which is the amount over the 80 per cent LVR. Put more simply, it becomes the parents' responsibility to pay for their child's debt if they pull out of the mortgage.
You as the guarantor might be putting your own home at risk if the child defaults on their home loan and cannot repay the initial sum guaranteed.
You might not also be able to take out another loan for yourself while you're listed as a guarantor.
More information and advice about what you might be in for as a guarantor can also be found on the federal government's Moneysmart website here. It includes a directory for free legal advice in each Australian state and territory if you wish to challenge a loan contract, for example if you felt pressured into becoming a guarantor, had a disability or mental illness at time of signing, didn't get legal advice before signing and didn't understand the documents or risks involved, or feel the lender or broker tricked or misled you.
