Time to read : 5 Minutes
According to the ABC, the median price for a house in one of our capital cities was around $928,000 a year ago.
Property values fluctuated a bit in 2023 but, according to CoreLogic, capital city house prices rose 453 per cent between 1992 and 2022. While regional towns may not have experienced the same rate of growth, it’s clear the trend of home prices is UP.
A University of Newcastle sociologist found that around 60% of younger Australians were relying on their parents’ help to get into a new home in 2020. That’s a massive increase from the 12% a decade earlier.
It's not just surging house prices impacting the trend either. Lower wage growth over the past ten years also plays a part. In 2010, annual wage growth was at 3%, but in 2023 it had only increased to 3.6% - which is well below the rate of inflation and, of course, the increase in house prices.
Enter: the BoMaD
First home buyers are facing their usual challenges in saving for their deposit (often while renting), plus finding the funds for all the other costs of buying a home, such as stamp duty. Lender’s Mortgage Insurance is another high-end cost if you’re borrowing at over 80% of your property’s value.
With low bank valuations common at the moment, LMI may also be needed if you’re looking to refinance, though this is less common. The BoMaD is - again - being called upon by young home owners desperate to refinance themselves into a better home loan after interest rates rose by 4.25% since May 2022.
A recent study by mortgage brokers reveals an increase of 71% in guarantor loans over the past six years, making the "Bank of Mum and Dad" (BoMaD) the 9th largest lender in the country, financing approximately $35 billion worth of loans*.
The Rise of Guarantor Loans:
The midst of a cost of living crisis isn’t the best time to ask your folks for hundreds of thousands in spare cash, which is why guarantor loans are soaring in popularity.
The main reason for this is that your parents likely have little to no mortgage left on their home, and their property has likely increased in value since they purchased it. This means they may have equity available to assist you in getting a foot in the door of your own home.
What’s a guarantor loan?
There are two main types of guarantor loans:
Security guarantor loans
Income guarantor loans
A security guarantor loan is the most common one in use at the moment. Your parents leverages the equity in their home to cover some (or all) of your home loan deposit, and possibly your stamp duty.
This often eliminates the need for a 20% deposit on your part.
This also allows you to avoid paying Lenders Mortgage Insurance (LMI), as well as the higher interest rate for your higher Loan to Value Ratio (LVR).
It works like this:
Judy and Alex save $50,000 towards their $500,000 home.
Stamp duty = $10,500
They’ll need to qualify for a loan amount of: $439,500 which is 88% of the value of their desired property.
This means they’ll need to pay LMI of over $10,000 on top - and this would push up the interest rate they can get, and their overall loan amount. Even if they can qualify for such a large loan, they won’t be able to comfortably afford the repayments.
Enter Alex’s parents, Phil and Clare, who own their own home worth $800,000. They have no remaining debt on their home. They agree to guarantee 10% of their home value against Judy and Alex’s purchase.
There will be two loans:
$80K against Phil and Clare’s $800,000 house, covering stamp duty and some of the deposit on Judy and Alex’s $500,000 new home.
$380,500 against the new home itself.
Our couple’s LVR is now 76%: well below the LMI threshold, saving Judy and Alex tens of thousands of dollars. They’ll also qualify for a lower interest rate because of their lower LVR, keeping their repayments affordable.
Guarantor Risks:
Judy and Alex are responsible for repaying both loans, and they’ll still need to service for the full amount borrowed, because this is a security guarantor loan only.
That said, while it’s unlikely Alex’a parents will end up having to make any repayments, they do become responsible for the debt if both Judy and Alex can’t meet their home loan repayments.
The type of loan where the parents are on the hook for repayments from the start is called ‘an income guarantor loan’ and these are a lot more risky. They’re also much harder to get because the guarantors have to pass servicing as well.
Most parents in a position to act as guarantors for their kids are either close to retirement age, or already retired, which means they’re not likely to service for income in any case.
That said, guarantor loans do come with the following risks for your parent/s:
They can’t sell their property while it still guarantees your home loan.
They're financially liable if you’re unable to meet your loan repayments.
Your parents can lose their home if you don’t make your repayments, and they can’t make them either.
Retirement plans, pensions, and existing tax arrangements your parents are planning on may be affected - and they should definitely consult their financial advisor on this.
Be Aware: Your parents will be interviewed by your broker and/or your chosen lender. They will be made aware of the above risks. They’ll also be asked questions to ensure they do not feel coerced. It’s illegal to pressure anyone to enter into any financial arrangement.
Exit Strategies:
If you're considering going down the path of using the Bank of Mum and Dad to get on the property ladder, then having a plan for removing that arrangement as soon as you can is important for you, and for your parents.
It’s also definitely something to cover off with your broker from the start.
Usually, refinancing to an 80% LVR as fast as possible is the best way forward. This can be achieved by you making additional loan repayments whenever you can, and also keeping a close eye on the value of your home.
A broker should be able to help with this. It’s their job to know when lenders might be favouring a particular postcode, etc.
In Judy and Alex’s case, another lender valuing their home at $575,000 in a few years means they can refinance a loan for $460,500 against their own home, pay out the $80,000 loan sitting against Phil and Clare’s house - and release them as guarantors.
To get there more quickly, they can also work to reduce their original loan amount.
Important: If you're planning to guarantor your children’s entry into the property market, please seek independent financial and legal advice to ensure you fully understand all of your - and their - risks and obligations.
The bottom line:
House prices are rising again.
Getting a new home loan - or refinancing an existing one - is harder than it’s been for years.
It’s becoming popular for young Australians to leverage their parents’ equity to gain access to the property market. Security guarantor loans are a common way to achieve this.
Parental assistance is also becoming necessary for existing homeowners seeking to refinance out of highly-leveraged loans.
Guarantor loans can be a smart solution, provided you’ve all sought your own financial and legal advice and understand all your risks and obligations.
A sound exit strategy for all parties should be discussed upfront.
