Family guarantee lending explained

A number of lenders allow members of the family to assist new buyers through a family pledge or family guarantee loan. The family pledge allows parents the opportunity to assist their children to purchase property without providing the cash for the purchase.

How does this work?

A family pledge allows family members to use their home as additional security to protect a whole amount of the loan or a portion of the loan. The extra security can reduce the LVR of the property therefore avoiding or reducing the LMI (Lender Mortgage Insurance).

Some lenders restrict the percentage held over the guarantor’s security and also require the guarantor to provide relevant documentation similar to the principle borrower to assess the guarantor.

The advantages of a family pledge:

• Reduce or avoids LMI
• Allows more funds to be borrowed if needed
• A guarantor can request to limit the guarantee to a specific amount
• The guarantor and borrower can request the release of the guarantee when the LVR requirements are achieved through reduction of loan or increase in property value
• Generally, there are no extra fees for a family pledge as it is considered similar to a guarantee and standard legal fees will still apply

What if the parents still have a mortgage on their home?

• The parents can still go guarantor as long as they have enough equity in their home (value of the house minus loan balance).
• However, most lenders will require all loans (existing and new) to be with the same lender. Very few lenders accept second mortgages by different lenders.

Who is a family guarantee right for?

• Even though every situation is different, family guarantees will only work if:
  • The parents have enough equity in their home.
  • The parents are happy to go guarantor. Most lenders will require parents seek legal advice first.
  • The children’s (borrowers) income is sufficient to service the entire loan amount
  • The application (including the family guarantee) meets lender policy

What is a guarantor?

• A guarantor is the related third party that provides additional security to help you buy your home.
• It is not the same as being a co-applicant or co-signer who is included on your loan and, like the borrower, is responsible for the entire loan until such time as it is repaid in full.
• A guarantor, on the other hand, is linked to thr loan by a guarantee and is only responsible for the amount of the guarantee and only until such time as it is released from the loan, which can be done at any time.

What if the children (borrowers) can’t meet their repayments?

• Family guarantees are not like the old style guarantees where mum and dad put their whole house on the line.
• These days guarantees with most lenders are limited to the amount specified in the guarantee and the loan remains in the children (borrowers) name – not the parents.
• So if something goes wrong – the bank will sell the children (borrowers) property first before activating the guarantee.
• And even if this did happen, the parents’ liability would be limited to their guarantee. Not the whole house.

How do you remove the family guarantee?

• You don’t want the guarantee to be in place for the entire term of your loan.
• A family guarantee should only be seen as a short term strategy and the aim should always be to release your parents of their guarantee as quickly as possible.
• The best time to ask for your family guarantee to be released is when the equity in your home is 20% or more.
• It usually takes 2 to 5 years to be in the best position to remove it.
• You can remove the guarantee if your equity is less than 20%, but you may have to pay LMI to achieve this.

An example of a family pledge

Maria would like to purchase her first home for $650,000 with a $65,000 deposit (LVR of 90%), which means Maria would have to pay LMI of $13,046.

Maria’s parents want to help her as the property is right next door. Maria’s parents own their home and want to provide some assistance.

They have plenty of equity in their own home. They agreed to offer a family pledge guarantee of $65,000 as additional security, reducing the LVR to 80%.

This would result in the LMI premium requirement being waived, saving Maria $13,046 and her parents would only be liable for the amount of the family pledge should Maria default on her loan.

Anthony Landahl | Equilibria Finance

This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.