Due to the huge amount of negative misinformation regarding guarantor home loans, I felt compelled to write this little article. You can find a long winded version here.
These types of loans may not be as risky as you think – and the child might move out of your home sooner
As a mortgage broker, we see all benefits and only one risk – the risk is that the child might stay at home…
Jokes aside, we would like to walk you through the pros and con (yes one), of a guarantor home loan. The guarantor home loan would be one of the most misunderstood facilities in lending.
We understand that it is a serious decision to put your home on the line with blind faith that the child (the applicant) will “do the right thing”.
Let’s look at the whole picture. Your child and his partner, now known as “The Applicant” has asked you to help them buy a property. To help them, they have asked you “the guarantor” to use your home a security. Basing this article on the assumption that the applicant had their house for two years and got divorced and now one wage will not cover the repayments. (We used a two-year assumption simply because the applicant’s ability to service the loan at the time of the purchase would have been assessed by the lender and approved. It is any future issues that are of real concern.)
What will happen now?
- In every Guarantor Home Loan, there will be two properties at least, being used for security.
- In the event that the applicant does not pay for whatever reason and the lender wants to take action to recover the debt, the applicant’s house is sold first.
- It should be safe to assume that the house would realise a sale price, similar to the original purchase price.
- There may be a residual debt left over after the sale of the applicant’s property. And there may not be. It is all going to depend on a few factors. The questions you need to ask yourself are the following:
- Did the applicant have a deposit when they purchased the property?
- Did the applicant pay extra each week on to the home loan and reduce the balance substantially?
- Did the applicant consolidate smaller debts into the home loan? If yes, were the payments from the consolidated debts added to the weekly home loan payments? (We would have advised them to do this at the beginning of the loan).
If the answer is yes to even one of these questions, then there is a chance that after the loan is repaid there will be no residual debt.
At the time of writing this article, the most that the applicant can borrow against a property using a guarantor loan, is 110% of the purchase price. The lenders will not allow a guarantors loan to be more than 110% of the purchase price under any circumstances. If our purchasers bought a home for $400,000, then the maximum loan would have been for $440,000.
- So, now we know that after the applicant’s property has been sold, you are not going to be responsible for the $400,000 debt. Let’s go a little further.
- There may be a small debt and there may be no debt. It really depends on the questions above and also for how many years the applicant had the loan for.
Let’s say there was a small debt left over and the applicant could still not pay it. Ask yourself the question, could you afford to refinance to cover that small debt of say $40,000? The repayments at 5.5 % would be under $60 per week.
This would be the absolute worst case scenario, where the applicant borrowed 110%, paid not one cent off home loan, made no contribution to the loan at all, had no deposit initially and then defaulted on the loan, forcing the lender to take legal action.
So what do we understand?
- We understand that the lender will thoroughly assess the suitability of the applicant to buy a home.
- In that assessment the lender will consider applicants income and their ability to pay the loan, along with their previous credit history and current commitments.
- Only after this has been thoroughly assessed and approved by the lender, would there be an offer for finance.
- The lenders are not interested in lending money if they can sense that there is a risk that the applicant cannot pay. I’m sure we all agree with that.
- This means that any risks associated with a guarantor loan, would be future risks. Something that has not happened yet, such as a divorce or loss of income. It can happen to any one of us, as we know.
As I mentioned at the start of this blog, we see mostly upsides and only one downside to this type of loan.
I would encourage you to read more about the upsides on our page, Information that every Guarantor needs to know. This page was not designed to sell you anything, we are your mortgage advisors, not salesmen.
Let’s talk about the downside to this loan.
In our opinion the one major risk of a guarantor home loan is when parents don’t know enough about their children’s circumstances.
A paragraph from our page, Information that every Guarantor needs to know:
As a guarantor, you will know the applicant much better than the broker will. You should consider carefully if there are any “red flags” about the applicant that you think should be discussed.
- Example: If the applicant is undisciplined with money. Continually obtaining consumer credit such as credit cards is a good sign of being undisciplined. Maybe they have a gambling problem etc.
- Example: If you know that the applicant is having difficulties at work. If there is even the remotest possibility that their income could be at risk, you should discuss this with your broker.
- Example: If the applicant’s relationship seems to be unstable. There may have been several separations for example in the last six months. You should discuss this also with your broker.
So what does all this mean?
In our opinion, it means that a guarantor home loan is not a bad option as long as the loan structure is set up for maximum efficiency.
We have set up many guarantor home loans over the past 16 years and we know the ins and outs of these loans very well. If you would like to have a chat about the suitability of this type of loan please feel free to call us on 0242 575 626.
We hope that information on our blog has been helpful.
Peter And Aleksandra.