The Bank of Mum & Dad: Understanding Mortgage Guarantors

For many first-time homebuyers in Australia, the property market can feel like a distant dream. Saving for a significant deposit can be a long and arduous struggle. This is where the "Bank of Mum & Dad" steps in. In property terms, this refers to family members, typically parents, who provide financial support to their children in purchasing a home. There are two main ways this can happen:

• Guarantor: A guarantor acts as a form of security for the lender. If the borrower (the child) fails to meet their mortgage repayments, the guarantor becomes liable for the outstanding balance. This can involve the guarantor's property being sold to recover the debt.

While guarantors are the most common method, there is a second option:

• Equity Release: This is less frequent and has stricter requirements. With equity release, a parent (or another close relative) may access some of the equity in their own home via a loan or reverse mortgage. These funds can then be gifted to the borrower as a larger deposit, helping them qualify for a mortgage without the need for a guarantor.

It's important to note that equity release comes with its own set of risks, and seeking financial advice is crucial before considering this option.

Types of Mortgage Guarantors

It's important to note that the specific types of guarantor arrangements can vary depending on the lender. Here's a breakdown of the most common options:

• Family Guarantee: This is the most common scenario, where a close family member, typically a parent, acts as guarantor. The guarantor's property secures a portion of the loan amount, usually up to 20%.

• Limited Guarantee: Some lenders offer limited guarantees, where the guarantor is only liable for a specific amount, rather than the entire loan balance. This can provide some security for the guarantor while still assisting the borrower.

• Vendor Guarantee: In less frequent situations, the seller of the property may act as a guarantor for a short period (usually up to 12 months). This can be helpful for buyers who are selling their existing property and need time to settle before having the funds available for a full deposit.

Responsibilities of a Mortgage Guarantor

Regardless of the specific type of guarantee, the core responsibilities remain similar:

• Financial Security: You should be in a sound financial position with a secure income and enough equity in your own property to cover the guarantee amount.

• Understanding the Loan: It's crucial to understand the terms of the mortgage your child is taking out. This includes the loan amount, interest rate, repayment schedule, and the specific guarantee details (e.g., percentage of loan guaranteed, limited liability amount).

• Open Communication: Maintain open communication with your child about their finances and their ability to manage the mortgage repayments.

Risks Involved

While acting as a guarantor can be a generous way to help your child, there are inherent risks:

• Financial Strain: If your child defaults, you could be forced to sell your own property or use your savings to cover the debt. This can significantly impact your financial security in retirement.

• Strained Relationships: Guaranteeing a loan can lead to disagreements or resentment down the line, particularly if financial difficulties arise.

How it Helps First-Time Buyers

Despite the risks, being a guarantor can be a significant advantage for first-time homebuyers:

• Lower Deposit: Guarantors can help borrowers qualify for a mortgage with a smaller deposit (often around 20% instead of the usual 20-40%). This frees up savings for other expenses or allows them to enter the property market sooner.

• Avoiding Lenders Mortgage Insurance (LMI): LMI is an additional cost some borrowers have to pay if their deposit is less than 20%. By having a guarantor, borrowers can potentially avoid this expense.

Considering Being a Guarantor?

Before committing to being a guarantor, seek professional financial advice to understand the full implications and ensure it aligns with your financial goals.

Finding the right mortgage deal can also be crucial. Consider consulting a qualified mortgage broker to explore your options and secure a competitive interest rate.

Remember, open communication with your child and a clear understanding of the loan terms are crucial for a successful guarantor arrangement.