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Should you 'go guarantor' to help your children buy into their first home - the Mum & Dad Bank.

This article was generated from a query from a client this month, she is close to retirement and we are working hard to make sure that she will have enough money to have a financially comfortable retirement.

But she is concerned that her son and his wife will not be able to get on that property ladder, and heard a snippet on Breakfast, from a commentator suggesting that parents could become a 'Mum & Dad' bank.

With entry property prices being so high, and more and more young people being unable to save a 20% deposit for a property - this is an approach that is well worth considering.

A traditional option for parents is to take money out of their retirement savings to help their child(ren) into a property.  The problem there is that those fund are gone and are not available to use in retirement.  However, if you 'go guarantor' then you are guaranteeing to the bank (via having a debt registered over your property) that the mortgage will be repaid.  That would seem to solve a problem, however there are significant risks to you in doing this.

What are the risks to you and the questions that you need to ask (based on my reply to my client)

1. There is a lot of risk to you in relation to the child defaulting on the mortgage payments (I have seen this happen with a client that I inherited from another adviser). You would have to be strong enough to make them move out of the house and sell it if that happened.
2. It would be vital that you make sure that they put in place income protection insurance, life insurance and trauma insurance that would protect you for your assets.  We can help them to arrange that to ensure that you are well protected.
3. You would absolutely need to make sure that this is all done legally - and any good lawyer would give you strong warnings as well.
4. The way that it would work is that you would put up the equity of one of your properties as security.
You need to talk through the different scenarios with your children so that you are all aware of what could go wrong.  In particular:
1. They have to make sure that the house and contents insurance is up to date all the time, and that the required maintenance is done in a timely manner.
2. What will happen if one of them loses their job (redundancy, poor performance) and there is a lag in time between getting another one - which impacts on cash flow.
3. What happens if they start a family and want to take time out from the workforce on parental leave.
4. What happens if one of them is ill and unable to work (that is where the income protection insurance and trauma insurance comes into play)
5. What happens if one of them dies (that is where the life insurance comes into play)
6. What happens if they split up - who will take responsibility for the debt and how would this work?
As the Banking Ombudsman adds:
Ask yourself whether:
  • this person can service the loan
  • you know this person's credit history
  • you know if he or she already has other obligations to the bank, and if so, what those obligations are
  • this person is likely to let you know if her or she starts finding the repayments difficult to make
  • this person is likely to tell you about any further loans he or she may take out
  • you could afford to meet all of his or her obligations
  • you can help this person in another way.
The responsible lending code has put more onus on the lenders to make sure that any guarantors are aware of the full implications of going guarantor.  The code requires lenders to "assist" guarantors and be "reasonably aware" of the full implications of going guarantor. Lenders must use plain English, should generally "recommend" independent legal advice (or require it if their home is at risk), and take extra care when dealing with "vulnerable" guarantors, including the elderly and intellectually weak. (Source, Rob Stock, Stuff).

In particular it is important to note that: Guarantees are generally broad, open-ended "all obligations" guarantees.

From the Stuff article (linked below)

Lawyer Barbara McDermott from Norris Ward McKinnon, said: "Guarantees can be complex documents which are difficult for a layperson to understand."

Ignorance is such that sometimes guarantors pulled out at the last minute when they realised what they were promising.

"Sometimes this happens because the guarantors do not fully appreciate the liability involved until they receive legal advice on signing the documents," she said.

The sometimes surprising extent of powers lenders have under guarantees can include:

  • The power of the lender to call in a loan on demand, so the guarantor could be called on to pay at any time.
  • The bank may have the right to take money from the guarantor's accounts without having to ask.
  • The bank being able to lend more to the borrower, and the guarantor be responsible for that as well.
  • The right not to have to keep the guarantor in the loop about missed payments, and additional borrowing made by the borrower.

And giving a guarantee can have personal financial consequences, McDermott said.

"If you wish to borrow money in future, your lender will take any guarantees you have given into account when deciding whether to lend to you."

That can be a problem that can hang around if the guarantee has no limit, and the bank refuses to release it.

Another point made in the Stuff article - is 'when it's okay to be a guarantor'

Limited guarantees on home loans: Westpac calls it the Family Springboard loan. The family guarantees a limited portion of the loan, which is set up as a completely separate loan. A person with a 10 per cent deposit, and parents providing a guarantee, would have a 10 per cent family springboard loan and an 80 per cent ordinary home loan. Together they are enough to get them to the 20 per cent deposit threshold. It'll save the borrower a bomb in interest, and the guarantee is extinguished once the "springboard" loan portion is extinguished.

Here are some links to useful resources if this is an issue that you think might be relevant to you:

 

 



 

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