What is a Family Pledge or Guarantor Loan?
What is a family pledge or guarantor loan? Well in simple terms, what we are saying is that parents or a family member can put up security to help a child buy a property. Now, why is this needed? In Australia, we do know that in the bigger cities, property prices are increasing more and more. And as they increase, it is becoming harder for the children, our children, to get into the market. So a family pledge loan or a guarantor loan is about putting up further security to assist your children buy property.
How it works is imagine if your son or daughter wanted purchase a property and they only have a 5% deposit. Well, that 5% deposit would mean that they are in Lenders Mortgage Insurance (LMI) territory. LMI is an insurance policy that protects the bank against the borrower defaulting. So if the borrower defaults and the bank don’t get their money back, they call in on the insurance company to ensure the bank get their money. Let’s face it, banks never lose. So what this is doing, you, as the borrower, have to pay a premium for the insurance policy. In some cases, that premium can be up to $20,000 so you could imagine helping your child by saying, if you only got 5% but you got a really strong income, then we will put some of the equity we have in our current home or one of our investment properties. So the bank takes a limited guarantee against that security for the period when the value of the property that you are buying and the loan against that property is above 80% in terms of the loan to value ratio. As that property price grows over time and the debt starts to come down and eventually, there is a 20% difference, then we can release your parents on that guarantee.
Basically, it allows the children to get into the market.
It means that they don’t have to pay this expensive one-off premium that protects the banks against your son or daughter from getting them into the market. It can be a great thing to look at getting them into the market sooner before property prices continue to grow and they are out of the reach of the average buyer. Now there are obvious risks, and those are laid out against the guarantor agreement. It’s important for you to seek independent advice to understand what those risks are. In other words, let’s say your son or daughter buys a property, say off-the-plan. They pay $500,000 for that property and the value is $450,000 at completion, and for whatever reason, they can’t service the mortgage but yet you borrowed $500,000. Well, the bank will call on you to pay out the difference, and that could mean that you have to foreclose on that property or you just pay them back over time. At the end of the day, the banks aren’t going to lose. So it’s important to understand the risks versus the rewards.
Now if you are saying that you got faith in your son and daughter, I’m sure that they are going to be committed to this long term adventure in terms of buying and owning a property. That’s what you need to sit down and talk about and then go on and get your own independent advice. But it certainly does help your children paying or saving the cost of this very expensive lenders mortgage insurance premium, and that’s why we say it’s worth considering when you are doing your research. Thanks for watching.