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In this episode
Mum and Dad might be willing to help you buy, but what are they actually signing up for? Imti explains how a parental guarantor works, what it can and can't help with and the questions both sides should understand before agreeing. Including how parents might eventually come off the guarantee.
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Thinking about buying your first investment property, or how buying your first home could shape your plans to invest?
First Time Property Investor (FTPI) helps you make sense of the choices and trade-offs that come before Investment #1.
FTPI Explained breaks down the concepts. FTPI IRL puts realistic first-investor scenarios to the test, showing what changes the decision and why.
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Thinking about buying your first investment property? Or wondering how buying your first home could shape your investment plans?
First Time Property Investor (FTPI) helps you make sense of the choices, trade-offs and advice that come before Investment #1. FTPI Explained breaks down the concepts. FTPI IRL puts realistic first-investor scenarios to the test, showing what changes the decision and why.
Join Imtiyaz Rather (Hack Mortgages), Pete Theodorou (Mindset Property) and Skye Taylor (Taylored Property) for perspectives across finance, buying and ownership.
Explore more ➜ www.ftpi.com.au
Parental guarantors explained. We have fifteen minutes to make it make sense, so let's jump into it. A parental guarantee can help you buy a property with a much smaller deposit and potentially avoid thousands in LMI. But the first thing most parents hear is, hang on. Am I putting my house on the line?
Speaker 1:The first thing most kids hear is, does it solve my borrowing capacity issue? We're gonna explain exactly what mom and dad are guaranteeing, whether they need to own their own home outright, whether their income helps you borrow more, whether this can be used for an investment property or not, and most importantly, are you a guarantor forever? One thing upfront, a guarantor solves a deposit problem, but it doesn't solve a borrowing capacity problem. So let's give you a really simple example of how it works. Mom and dad aren't giving their child cash.
Speaker 1:Instead, they're allowing a lender to use a certain amount of equity in their property as additional security for their kid's loan. Now that might sound like a bunch of word vomit, so I'll give you an example to put it into practice. For example, let's say Tom is a kid, and he wants to buy a property that's worth $500,000, and he only has $25,000 in the bank. If Tom was only eligible for a home loan that required a 20% deposit, he would need to have a $100,000 in the bank. By using a guarantor, Tom's parents can offer $75,000 worth of equity in their property.
Speaker 1:Tom can put in $25,000 cash, and so long as he can borrow the $475,000, he can borrow all of those funds and not have to pay lenders mortgage insurance. Essentially, it means is Tom can purchase the property without needing a 20% deposit. He can avoid lenders mortgage insurance, and the other cool thing is actually if he didn't wanna put any money in, if there was enough equity in his parents' property, he could borrow the full 500,000, Or if he had to pay stamp duty, he could borrow the 500,000 plus the stamp duty plus legal fees plus pest and building. But the important thing to note is that it doesn't help with borrowing capacity. Still needs to be serviced on Tom's income alone, and the parents just offer equity in their property to help him purchase that property.
Speaker 2:As the only parent here
Speaker 1:Mhmm.
Speaker 2:My first thought is how does this play out if one of my kids were to default on the loan? Am I liable? Can they take my house? What's... What happens?
Speaker 1:This is probably the number one question from all parents whenever in this situation. So there is a risk, but the risk isn't as big as most parents think. What's in place is called a limited guarantee. So we'll use Tom's example, where his parents would be guaranteeing $75,000 out of the total loan amount, for example. And so your exposure is generally capped to around that much, around 20 to 27% of costs.
Speaker 1:And through that process, you get a whole bunch of fancy documents from the bank that'll line out what your risks are. And usually, you're encouraged to get independent legal advice. In real terms, though, what that looks like is that the bank will go after the parent's property last.
Speaker 2:Because Tom's property is still
Speaker 1:Exactly right. It. So let's say Tom nicks off to Bali, disappears off the face of the earth, doesn't wanna make a repayment ever again. The bank most likely repossessed Tom's property, sell it, and then whatever's left over, they would approach you to have a conversation about it. So they wouldn't immediately go to repossess
Speaker 3:your property.
Speaker 1:They would offer you the opportunity to pay out the limited guarantee, and usually, they'll work with you in terms of negotiating some sort of payment plan or something like that. For most banks, they're not really in the business of making parents homeless. That is legally also their right. So what they can do and what they will do sometimes are a little bit different.
Speaker 2:Yeah. So hypothetically, there's no equity. And so as a parent, I'm liable for that 75.
Speaker 1:Mhmm. That's it. So whatever the limited guarantee is that's outlined in the documents
Speaker 2:Yep.
Speaker 1:That's your exposure.
Speaker 2:So it's not like a formal second loan, but that's the liability.
Speaker 1:Yep. So there'll be a second mortgage that's applied to the
Speaker 2:property. Okay.
Speaker 1:But your exposure is only capped to that much. And I think the other important thing to call out is that the second Tom misses a repayment, the bank notifies you. So you don't find
Speaker 2:out yelling at Tom. Yeah. Yeah. Pay your bill.
Speaker 1:Exactly right. You don't find out when he's twelve months behind and have sold his house. The second that he misses a repayment, the bank's actually obligated to let you know that it's happened. And that's where one of the biggest things that we do with parents upfront is making sure that there's a clear division of responsibilities and everyone knows exactly where they're sitting. Long story short, yes, you're at risk, but you're probably not at as much risk as you think you are.
Speaker 2:So what about if I still have a mortgage on my property? Do I need to clear that before they can access the equity?
Speaker 1:Great question. So the answer is no. Most banks, they will allow a guarantor to go up to 70% equity in the property combined between all the debt. And so what that means is, say your property's worth a million dollars and you've got $500,000 worth of debt left on
Speaker 2:it Mhmm.
Speaker 1:The bank might allow that guarantee to go up to 70% of that 1,000,000. So you could guarantee 200,000. So then you would have $500,000 mortgage with whoever your lender is, and then the bank might let you guarantee up to $200,000 for your home.
Speaker 2:Because that would take me...
Speaker 1:Okay. I'm fine. Percent of loan balance. Yep. And so that surprises a lot of people because most people think that they do need to own their own home outright or they need to have very minimal debt.
Speaker 1:The reality is is that most lenders will let you go up to 70% of the guarantors property value.
Speaker 2:Yeah. What about... Sorry. Just another question. Mhmm.
Speaker 2:What about if I have three children? Obviously, the 70% applies.
Speaker 1:Mhmm.
Speaker 2:So I've only got that 200 to play with. Are you then allowed to do it for multiple children?
Speaker 1:Great question. Generally, the answer is no.
Speaker 2:So you can only... You have to pick your favorite child?
Speaker 1:Well, that's when you would sequence it across Okay.
Speaker 2:The kids. Timing wise.
Speaker 1:Timing
Speaker 2:wise. So assuming that they're all different ages, thanks. That's helpful.
Speaker 1:Yeah. That is helpful. But there is one or two lenders who will entertain multiple guarantors if all the lending is with them.
Speaker 2:Mhmm.
Speaker 1:But in general context, it's also something that we just wouldn't recommend someone do because the amount of risk to the guarantor. Sure. If multiple kids disappear. But, no, the parents don't have to own their properties outright.
Speaker 3:So we've probably focused more so on the owner occupier side, but what about from the investment standpoint? Do the guarantors work?
Speaker 1:Yeah. So this is something that not a lot of people realize is that there is some lenders that will let you use a guarantor for investment property purchases. That's something that we do pretty regularly, and it works very similarly. Same thing, same limited guarantee caps, just less lenders who are open to doing it, and then just a few more things that you need to be aware of when using it for an investment property.
Speaker 3:And then borrowing capacity. So obviously, you're getting the rent from the investment property.
Speaker 1:Mhmm.
Speaker 3:How does the borrowing capacity flow through?
Speaker 1:So the borrowing capacity still will be calculated off the applicant's income, and then the rent that would be coming in, we'd be able to factor that in. So let's say Tom's living at home not paying any rent, We could use a lender that looks at that favorably, add the rent, add Tom's income, and in theory, he can actually purchase an investment property for more using a guarantor than he would be able to purchase an owner occupier property. The important thing here is that the parent's income still can't be used and isn't used across any guarantors to increase the borrowing capacity.
Speaker 3:Yeah. So it's basically just getting your own loan. As you would personally, it's all based on your ability to repay the loan plus the rental Yep. And nothing to do with the parents.
Speaker 1:100%. The only way the parents help in this situation is by reducing the deposit amount and potentially saving you on lender's mortgage insurance.
Speaker 3:The parents aren't paying the loan either. Is that a common question as well? It's like, how are we gonna actually afford to repay this?
Speaker 1:Mhmm.
Speaker 2:Did they need to consider it as a backup plan if Tom buggers off to Bali?
Speaker 1:Definitely. The parents should consider their level of exposure. That's where we have a preference to recommend lenders that will require independent legal advice. Some brokers won't do that because they think that it's saving the client money because legal advice costs money. Mhmm.
Speaker 1:We're on the other side of the fence where we would rather recommend that the client pay for the legal advice, go see a lawyer independently. Because as much as we can educate them around their risks, us being brokers, lawyers are lawyers, and so we'll always be on the side of the guarantor and looking after them more than the kid. My job in the process is actually to try and break the guarantors, frame around it if they're really, really enthusiastic, and make them see the downside of it all and do it knowing the downside.
Speaker 2:I've seen so many scenarios where, you know, parent puts child into rental property and it's not gone well. Mhmm. So the guarantor scenario would be a... Probably a less riskier option. If there's parents out there thinking, well, I'll just let my child live in my rental property, that goes a lot worse.
Speaker 1:Mhmm.
Speaker 3:Yeah. This would be a safer option because, basically, they've gotta repay the debt.
Speaker 1:Exactly. Kids have the same child. The onus is on them to make
Speaker 2:the the number of children I've seen not pay rent
Speaker 1:to parents. Yeah. Yeah. Yeah. Huge.
Speaker 2:And the parents are like, oh, I can't Yeah. I can't pay this mortgage because the kid's not doing what the kid should be doing. Yeah. I like that better.
Speaker 1:Yep. Whereas if the bank's chasing you, you're gonna pay them.
Speaker 2:Yeah. But I see it happen often that parents will buy the rental property for the child to live in. Speaking of... As a parent thinking this through, how do the parents get out of this, or are they locked in for the next thirty years?
Speaker 1:Mhmm. Most parents do think that they're locked in for thirty years. So no is the answer to that question. The way that it works in practice is as soon as there's enough equity in the property, so as soon as there's 80% loan to value ratio, in Tom's example, let's say he pays the debt down to 400,000 and the value of his property just stays flat at 500,000, we can then go back to the lender and just request that the lender remove the guarantee. So it doesn't even need to involve a refinance.
Speaker 1:It's just submission of a discharge form, and it can get rid of the guarantor on the property.
Speaker 2:Right.
Speaker 1:What usually happens with our clients is we game plan it over eighteen to twenty four months with the parents, and we go, this is what your repayments need to be to bring down the debt as quick as possible. And if the property grows by five to 6%, this is the timeline point that you'll be able to remove the guarantor. Okay. The other thing that we will do there is actually lenders will value properties differently, and so we can essentially try and get the best valuation for the property so we can remove the guarantor ASAP. Yep.
Speaker 1:And that's something that we'll do essentially at twelve month intervals with the clients to try and get it out of the way. So instead of thirty years as a guarantor, it's more like two years.
Speaker 2:That's what you say on average?
Speaker 1:Yeah. That's what we're working with at the moment. Two years, worst case scenario, four.
Speaker 2:Okay.
Speaker 3:So we focus on all the positives
Speaker 1:Mhmm.
Speaker 3:But every decision has a risk. What do you see is the biggest risk here?
Speaker 1:I think the biggest risk is cash flow. So the borrower's cash flow, obviously, they're borrowing more. Second component of that is buying the right property type because they're borrowing more than a 100% of the property's value a lot of the time. If the value of the property doesn't go up, they're stuck because they're negative equity from day one. And the third thing I would say is using it as an excuse to not have enough cash savings in the bank.
Speaker 1:Often, people will try to use a guarantor, and then once they own the property, they have $5 in the bank afterwards. And we all know realistically that's just a recipe for disaster. The guarantor's at risk, the client's at risk, and often in that situation, we'll actually tell the client to go away and save more money and come back, or explain to the guarantor that you might need to help them out if something goes wrong from a cash flow perspective. Yeah. To me, it would be cash flow and asset selection.
Speaker 3:Yeah. It's assuming every property grows, which is the worst assumption you can make at the moment.
Speaker 1:Yep. Exactly right. That's probably a good place for us to put a cap on the explainer for guarantors. For anyone listening to this, if they were to remember one thing, if you're a parent, remember that you're not stuck forever. The risks probably aren't as bad as you think that they are.
Speaker 1:Partner with a broker who puts your best interest first and almost tries to talk you out of it. And if you're on the other side of the fence and you're a tom looking to use a guarantor to get into the market, it will be understanding that it's not gonna solve your borrowing capacity issues, but it will save you on LMI, and it will get you into the market quicker.