What you should know about the Bank of Mum and Dad

What you should know about the Bank of Mum and Dad

Financial guarantees: ins and outs

Pulling the deposit together to buy a first home is a tougher proposition than it once was.

The Bank of Mum and Dad has done brisk trade as a result, as more parents step in to help their offspring via gifts, personal loans, or providing guarantees for mortgages they may otherwise be unable to obtain.

NAB has seen the number of first home buyers using guarantees rise from 4.8 per cent in 2010 to 8 per cent in 2016, and other major lenders have noted a similar trend.

Before entering into such an arrangement, though, it’s essential to understand what a financial guarantee entails to make sure it‘s fair for all parties.

Getting a guarantee

A lender may request a guarantee if it’s unwilling to provide an individual or couple with a loan under their own steam. This typically occurs if the applicant has an insufficient deposit to meet the institution’s lending criteria.

A guarantee is an agreement that sets out that a third party, known as a guarantor, will be legally responsible for all or certain aspects of a loan, potentially including interest, fees and charges, should the borrower default on repayments.

A guarantor has no rights over a property for which they’ve provided a guarantee. But they may be able to apply to a lender to have their guarantee removed once specific conditions are met, for example, when the borrower has amassed a percentage of equity in the property, or is able to prove they can service their loan unaided.

Risks and rewards

Having your folks lend some financial muscle can help you get on the first rung of the property ladder sooner, or allow you to afford a better place. But it’s important to understand what you’re getting them into before you ask them to guarantee all or part of your loan.

They will potentially be taking on a lot of risk for no personal benefit, says Smart Advice financial planner Peter Horsfield.

Guaranteeing your loan can limit your parents’ ability to borrow money themselves, as potential lenders will chalk your debt up as their liability, even if you’re making your repayments dutifully and they’re not a cent out of pocket.

And selling their own home may become an issue for your parents if it has been used as security for yours. Your parents’ credit rating may also be on the line if you default on repayments.

Family friction

There’s plenty of potential for family friction should you or your parents’ circumstances change while you’re financially entwined, Horsfield says.

“Have a frank conversation about the ‘what-ifs’ – like how you’ll deal with worst-case scenarios, such as job loss or relationship breakdown – before you ask your parents to provide a guarantee,” he advises.

Professional advice can help both parties understand their respective positions, and may identify alternative options to help you get into your own place without exposing your parents to unnecessary risk.

Guarantees can be a great tool for parents who have the financial capacity to help their children get into the property market. But it’s important for both parties to understand their rights and responsibilities before entering a guarantee arrangement.

DISCLAIMER: The information contained in this article is correct at the time of publishing and is subject to change. It is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, Smartline recommends that you consider whether it is appropriate for your circumstances. Smartline recommends that you seek independent legal, financial, and taxation advice before acting on any information in this article.