Q: Our daughter and her partner have approached us to act as a guarantor on a loan to buy their first home. They have a deposit, but it is insufficient for them to take on the home loan. What are the risks we should consider?
A: If you are looking to help your child into their first home, there essentially are three ways that you can assist. You can either gift or lend an amount sufficient to meet their deposit obligations or alternatively you can act as a guarantor on their home loan.
Be clear about the terms of your assistance. Be careful about imposing conditions on the gift and changing those conditions. Once you have passed the money to your child, they are free to make any financial decision they like for the use of these funds.
If you lend money to your child, ensure you have a legal agreement in place. This should clearly outline all parties’ rights and obligations. It also protects you in event that their relationship ends or either was to be become bankrupt. You are not obliged to charge interest on this loan however the purpose of the agreement is to protect your interests. Note any interest you charge will be treated as income for tax purposes.
It is important to confirm they have their finance approved with a bank prior to you committing to any gifting or lending. Please be aware that any money gifted or lent may be taken into consideration when the bank determines their ability to service a loan facility.
An alternative to gifting or lending is to act as a guarantor on their loan with a lending institution.
There are a range of guarantor options provided by lenders in the market. The loan guarantee can be in the form of security against your property. The title for the property purchase would be in their name. Alternatively, the guarantee can be in the form of shared equity where you may share in any capital growth in the property whilst the title remains in their name. Under either scenario, your child should be eligible for any ”first-home buyer” concessions subject to meeting the criteria.
The benefits of being a guarantor are that your child will be able to buy a home a lot earlier then their savings may have allowed, thereby saving on future rent costs. By utilising the equity in your home, they may avoid the impact of lenders mortgage insurance. This may mean that they have greater savings to purchase the home rather than funding purchase costs.
As a guarantor on your child’s loan, you do face risks. The child’s relationship may end which may necessitate the sale of the property and financial disruption to you. If they do not fulfil their obligations with the bank you will be responsible for those repayments, which may put your property at risk.
Becoming a guarantor may affect your ability to borrow in the future as the loan guarantee will be taken into consideration as part of any lender’s serviceability calculations. If the loan was to fall in arrears or default, your credit rating would be put at risk.
Once they have enough equity in their home, you should aim to remove your guarantee off their loan. Come to an agreement with your child and their spouse to a likely time frame to remove your obligation as a guarantor.
Ensure that you and your partner both agree to assisting the kids. If you were to divorce, any monies gifted or lent would need to be taken into consideration as part of a property settlement.
Before you gift or lend money to your children, ensure any assistance you provide will not impede your own retirement savings or financial circumstances.
If you have more than one child, be mindful of your ability to support your other children on a like basis in the future.
As parents our natural response is to want to help our children. Ensure you clearly communicate how you will help and what your expectations are. Be mindful of the consequences to your relationship with your child or their relationship with their spouse if things do not go to plan.