Family Guarantors, money and mortgages and what you need to know

2021-06-13
Loaning money to your adult children. Does it free them, limit them or teach them? It probably depends upon how you plan to do it? Loaning money to your adult children. Does it free them, limit them or teach them? It probably depends upon how you plan to do it?

Are you considering asking a family member to become your Guarantor for a mortgage?

Here are some things you need to know and do- first

  • One of the questions about home loans and mortgages we're regularly asked by older clients is, ‘Can a parent go Guarantor to a Mortgage to help one of their adult children?’
  • Their adult children usually ask a variation on the same question,  ‘When can a parent go guarantor to a Mortgage loan?'
  • The real question people want to ask is 'Should you ever become a Guarantor to a Mortgage?'

Jump Ahead

The best decisions are usually the ones you don't have to rush

However you decide upon your answer to this question - the reasons should be carefully considered and their advantages and disadvantages mapped out over a long period of time.

  • Never make these types of decisions in the stressful period of a forced property purchase.

Quick decisions have long consequences

It's always easy to make fast decisions with other people's money.

  • Let me say from the outset, I’m all about helping kids learn responsibilities with boundaries so they have the best chance to learn and succeed on their own in the real world.
  • When people are hesitant at first doing the learning, my professional experience to date has been these same people are equally hesitant at taking responsibility for the outcome of their decisions, and are quick to walk away from a financial mess, citing its everyone else's responsibility, other than their own.

Are you thinking about helping your kids get their first mortgage?

Speak with any parent of teenagers and you’d hear a lot about the challenge of ‘wanting the best for your child’ and ‘not wanting to rescue them from learning from their own mistakes’.

Truely, helicopter parenting has a lot to answer for.

How do you begin to balance the risks to reward?

But what about our adult (or soon to be) children?

How does a parent's decision to give a child a financial ‘hand up’ balance the risks of not putting themselves in harm's way at the same time?

You need to clearly understand both sides of the same coin

The positive side of the coin

We all know that early on in our lives, we have built very little financial savings, wealth or independence and having a parent there to give us a leg up with life's initial challenges, can be a real benefit. Whether this help comes in the form of a gift or a loan, having support helps create connection.

As a parent who's able to help financially, the opportunity to help can provide a tremendous feeling of importance, dependence and connection to an older child, (or grandchild's) life.

How and whether we make this happen still requires personal responsibility and a plan, on everyone's part.

The other side of the coin

No honest conversation about financially helping an adult child is complete, without an honest assessment of the other side of the coin.

  • Not all financial help is good.

Gifts can create unintended experiences of entitlement and dependence.

There are times when you should never borrow from family and never let them act as your Guarantor

Sometimes money is used in family systems to hurt or control and can lead to a feeling of financial enmeshment and a blurring of healthy boundaries.

  • And if you add to this a cultural overlay of traditional expectations, extended family hierarchies and beliefs that children must carry on the family name, tradition, status or position in the community - and you may be creating a nightmare just over the horizon that nobody has the courage to talk about today - or the experience to make a backup plan for.

Elder abuse and manipulation is also a warning sign mortgage assistance providers and mortgage brokers are required to look for in these types of specialty situations.

So what's possible?

Is it possible for an adult to go guarantor for an adult child's Mortgage?

Yes. An adult with a sizable savings account balance or equity in their own home, can become a Guarantor for the mortgage of an adult child or relative.

What type of mortgage is used for Family Guarantee Loans?

This mortgage structure is usually called a Family Pledge or Limited Family Guarantee Mortgage, and is where a family member acts as a Guarantor for a portion of a loan as collateral.

Can a person specify the amount of the loan they act as Guarantor for?

Yes. Usually this is contractually limited to only 20% of the total borrowed amount.

Is there a risk in being a mortgage guarantor?

Yes, absolutely.

If you’re Guarantor to a loan of any kind, you also become responsible to make sure the loan is repaid - even if your co-borrower is sick or injured and cannot work, or if they just decided to walk away from it because they don't have any of their own personal saving invested into the loan.

Additionally, if the housing market where the particular property is located is not growing in value, it may be difficult to expect the increased capital growth alone to reduce the mortgage debt quickly, so you can remove yourself as a Guarantor.

Add to this a divorce and a challenge to a Will and you can have a mess on your hands.

How can you reduce the risks as a mortgage Guarantor?

  • Firstly, ensure that your relationships with all parties are positive and stable before even considering this assisted borrowing strategy.
  • Watch for the responsibility markers in your adult children before you even consider this assisted mortgage strategy.
  • Have a personal standard that, 'you never lend significant amounts money to family members without first securing a signed Family Loan Agreement (this will help keep them safe if a divorce or relationship breakdown occurred during the loan period). You can read more about that here.
  • If there is any sign of addiction, gambling or business or relationship troubles, that's a warning sign to heed.

Why would someone want to use a Mortgage Guarantor for a mortgage?

  • The reason can be as varied as the people who use them but it's usually to reduce the fees involved in getting a bigger mortgage with a smaller than usual deposit.

It starts with a clear understanding of what is Lenders Mortgage Insurance

  • When you borrow more than 80% of the value of a property from a bank, you have to pay the bank's Lenders Mortgage Insurance premium (commonly referred to as LMI or Risk Fee).

  • The big idea behind LMI is reducing risk to the funder so they may be prepared to lend more on a mortgage.

Pro Tip: LMI only protects the bank in case of the borrower defaulting on the loan and can cost upwards of $10,000 to 1% of the loan total.

How does LMI work in practice?

If the property you wish to purchase is increasing in value faster than you can save the 20% of its value as a deposit, many funders may offer to lend up to 95% of the contract price as long as you have 5% genuine savings.

  • Others may require more or less depending upon the current economic conditions and the security of your type of employment, but both will require you to pay their Lenders Mortgage Insurance Premiums.
  • This is often referred to as the LMI or a Risk premium.
  • The more you borrow from a funder above 80% of the property price you wish to buy (or refinance) the higher the amount of LMI premium you will pay.

If you have an acceptable Guarantor who is prepared to offer as security the equity in their own property to 20% of the new loan, you may not require Lenders Mortgage Insurance and therefore a considerable saving is made.

Pro-Tip. People employed in COVID19 sensitive occupations like hospitality and travel, may face additional requirements to meet.

8 Essential steps to take, before you ask someone to become your Mortgage Guarantor (or before you decide to be a Mortgage Guarantor)

Understand that becoming a Guarantor to somebody else's Mortgage is a big responsibility.

And you need to have a good reason to be confident in the borrower's financial situation (and yours) to handle it.

  1. First, have a private Family Loan Agreement documented and in place (before you apply for a Mortgage Guarantor Loan.)

  2. Make sure all parties to a Mortgage Guarantor/Family Pledge Agreement loan have their own up to date Wills and Powers of Attorney in place (before you apply for a Mortgage Guarantor Loan.)

  3. Make sure the borrowers have both Life insurance and Income Protection in place (before you apply for a Mortgage Guarantor Loan.)

  4. Make sure all the borrowers have their Life Insurance and Super Fund policy nominations in place and up to date (before you apply for a Mortgage Guarantor Loan.)

  5. Have a plan that is reviewed regularly to remove the Guarantor to the mortgage as soon as you can by;

         Increasing the resale value of the security property (capital growth), and

         Reducing the mortgage debt with additional repayments. Understanding how to use a 100% offset account may also be helpful.

  6. Agree together, the property is to remain fully insured for fire and storm damage during the Guarantors period

  7. Be prepared to contractually only Guarantee 20% of the loan total.

  8. Have your financial adviser walk you through the process first.

Deciding to ask a parent or a relative to be the Guarantor of your home mortgage is a very big step.

Respect their freedom to say Yes or No, or Wait, and an appreciation your actions will also financially affect another while they stand as Guarantor for you, is the first step in preparing for the opportunity and increased responsibility that another may offer you.

If you're the one considering standing as mortgage Guarantor for a relative, make sure you have good reason to understand their financial abilities, their level of responsible preparation completed already and plan to actively review your position once a year with a view to stepping down as Guarantor as soon as you can.

Contact us today and see if we're the type of people you'd like to work with.

Drew Browne

Drew specialises in helping people protect and provide for what matters most in their lives. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His company Sapience Financial is committed to using business solutions for good in the community, and in 2015 certified as a B Corp. In 2017 Drew was recognised in the inaugural Australian Westpac Businesses of Tomorrow National Awards. Drew writes for successful Small Business Owners and Entrepreneurs at Smallville, his blogs can be read on Amazon.com and you can connect with him on LinkedIn.

Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.

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Drew Browne

Sapience Founder & Director.
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