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Why going guarantor on your child's loan may not be a good idea

It’s estimated that roughly 60 percent of first home buyers receive some kind of financial assistance from their parents.

That makes the ‘Bank of Mum and Dad’ (BOMAD) Australia's ninth biggest lender, with around $35 billion in outstanding loans. For generous parents, there’s substantial risk attached to this largesse. 

According to research conducted by comparison site Finder, over 50 percent of kids who borrow money from their parents are under financial stress (compared to 23 percent of regular property buyers). So opening your own BOMAD is especially risky if you also elect to go guarantee on your child’s home loan.

Going guarantor is basically saying to the bank that you’ll pay off your child's debt if they can’t. This may be all right if you’re certain your child is going to make good the loan, but if they don't you will be left holding the entire debt. Sobering, isn’t it? Especially when you consider that at 50 percent the risk of your child defaulting on the loan is about the same as tossing a coin. How willing are you to bet your life savings on it coming up heads?

If you still want to go guarantor

If you really want to help the kids and see no other way to do it (see below), here’s what you can do to limit your risk.

1. Seek professional advice

This is a financial transaction, so get the support you need (accountant, financial adviser, solicitor) to be certain you’re not in over your head.

2. Insist on an upper limit

Make sure there is an upper limit on the guarantee on which you’ve agreed.

3. Get a cancellation agreement

Have an agreement in place where once the kids have paid down the loan to have sufficient equity, then your guarantee is cancelled. Most home loan providers will agree to this if the equity in the property reaches at least 20 percent over and above the loan. If property values have substantially increased in the area, a valuation of the property by the home loan provider can also kick this process off.

You don’t have to go guarantor

Fortunately, there are few other ways to help the kids buy a house without risking your own. Talk to your financial adviser and solicitor about implementing one of these strategies. Just remember the golden rule: never help the kids out if it means putting your own financial security in jeopardy.

1. Welcome them back

Maybe your kids are paying exorbitant rent a few suburbs away, or maybe they never moved out in the first place, but either way a relatively risk-free, low-cost way to help them buy their first home is to share your own, rent-free. No rent, no bills and if you can manage to kick in most of the money for food as well, they’ll be well on their way to saving what they need.

2. Buy it with them

Before you even consider this option, make sure you have a rock-solid agreement in place. A tenancy in common agreement assigns the partners direct ownership of a nominated portion of the property. It means each party is responsible for their own mortgage and share of the property. So you’ll have a distinguishable separate title to your part of the house, and you won’t be lumped with the full mortgage should your child default on their portion of the loan.

Note that this type of arrangement could put your relationship with your kids under pressure. Not just the one you’re buying a house with, either. If you thought the sibling rivalry was rife when they were growing up, it will know no bounds if you buy a whole house for one and not another…

3. Lend them money

Use a third-party administrator like an accountant or solicitor to set up a proper loan agreement. That way you’ll have a clear loan repayment strategy in place and you’ll know exactly where you stand throughout the life of the loan. Having a third-party administer the loan will also put a formal buffer in place and add gravity to the agreement.

The information provided in this article is of a general nature only and should not be considered as a recommendation or endorsement by PSPL of any product, service or advice contained in this publication. Please consider your personal circumstances and seek professional advice, if necessary.