A question we are often asked by parents considering a guarantee for their son or daughter buying their first home is “what are we actually signing and what is the risk involved”.
Before answering the question we need to put some context around the reason the lender is asking for a parental guarantee. Most lenders will advance up to 80% of the value of the property being purchased without the need for a guarantee however when the advance is greater than 80% there are two options available to the purchaser. One is the guarantee and the other is Lenders Mortgage Insurance otherwise known as LMI.
Lenders Mortgage Insurance means an insurer takes the risk on behalf of the lender but it is the purchaser, the lenders client, who pays the premium and the premium can be very expensive. Thousands and thousands of dollars depending on the size of the loan. Some lenders will allow the client to add this premium to the loan but of course this means a bigger loan and higher repayments.
The second option is the parental guarantee so using a hypothetical scenario let’s say your son wishes to buy a home for $500,000 but he only has a deposit of $50,000 or 10%. That would mean the lenders exposure is $450,000 or 90% of the value of it’s security.
Now to get down to the 80% and do away with the cost of LMI your son or daughter might approach you for a guarantee and this is where it gets a bit tricky. What are you being asked to guarantee and what are the consequences?
Well essentially you are being asked to guarantee the bank’s risk and therefore any shortfall should your son or daughter default and the home is sold for less than the amount of the outstanding loan.
Now if you are still interested some lenders, and we know which ones, will take a limited guarantee to the amount that covers their exposure beyond the 80% mentioned earlier. In the aforementioned case the guarantee would be $50,000, ten percent of the purchase price and the deposit of $50,000 makes up the other 10% meaning the lenders exposure is 80% and within their risk guidelines.
Now you can read part two called “what happens if”.
Australian Credit License No. 377093
