What is a Parental Guarantee Loan?
A Parental Guarantee Loan allows parents to assist their children in securing a home loan by providing additional security or income support. This can help first home buyers enter the property market sooner and avoid paying Lenders Mortgage Insurance (LMI), which can sometimes cost tens of thousands of dollars.
Types of Parental Guarantees
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1. Security Guarantee
A Security Guarantee involves parents using the equity in their own property as collateral for part of their child’s home loan. Instead of providing cash, parents allow their property to be used as additional security for the loan. Some lenders may also accept a Term Deposit as security.
This option helps borrowers with a smaller deposit secure a loan and avoid paying LMI. For example, if a home buyer has only saved 5% for their deposit, their parents could offer a guarantee for 15% of the loan, helping the borrower reach the 20% threshold required to avoid LMI. Some lenders may even allow parents to cover up to 110% of the property price, which can also include extra costs like stamp duty.
2. Servicing Guarantee
A Servicing Guarantee occurs when parents assist with the borrower’s loan repayments using their own income. This is helpful in situations where the borrower’s income isn’t enough to meet the bank’s serviceability requirements.
In this case, the parent becomes a co-borrower or guarantor. The bank will need evidence of the parent’s income to ensure they are financially stable enough to support both their portion of the loan and the full loan amount. This type of guarantee is most suitable for parents with high incomes and a strong financial position.
Benefits of a Parental Guarantee Loan
A parental guarantee can offer significant advantages, both for the borrower and the parents. Here are the key benefits:
1. Avoid Lenders Mortgage Insurance (LMI)
By providing additional security for the loan, a parental guarantee can help the borrower avoid paying LMI, saving potentially thousands of dollars.
2. Lower Deposit Requirements
First home buyers can enter the property market sooner with a lower deposit, or even no deposit at all. Some lenders may offer up to 110% of the property value, which can include costs like stamp duty.
3. Improved Borrowing Capacity
With the parents support, the borrower’s borrowing capacity can increase, which may help them afford a larger loan. This is particularly helpful when looking to purchase a property in a more desirable area.
4. Better Interest Rates
A stronger financial position, due to the guarantee, may allow the borrower to access more competitive interest rates, helping to reduce the overall cost of the loan.
Risks of a Parental Guarantee Loan
1. Risk to Parents Assets
2. Limited Borrowing Capacity for Parents
3. Financial Strain on Parents
4. Potential for Family Conflict
What to Consider Before Offering a Parental Guarantee
Before you decide to offer a parental guarantee, consider the following steps:
Understand the Guarantee Type
Make sure both the parents and the borrower fully understand the type and extent of the guarantee being offered. This ensures everyone is aware of their responsibilities.
Seek Legal and Financial Advic
Parents should seek independent legal and financial advice before agreeing to any guarantee. This will help ensure that the arrangement is in their best interest.
Consider a Limited Guarantee
Instead of offering a full guarantee, parents can opt for a limited guarantee, covering only the necessary portion to avoid LMI.
Plan for an Exit Strategy
Discuss how the guarantee will be removed in the future, such as when the borrower has built enough equity in the property.
Review Loan Terms
Some lenders allow for the early release of the guarantee once the borrower has reached a certain level of equity. Make sure to check the terms and conditions of the loan.
Frequently Asked Questions
A parental guarantee loan allows parents to provide additional security for their child’s home loan. This can help the child avoid paying Lenders Mortgage Insurance (LMI) and secure a loan with a lower deposit.
The two main types of parental guarantees are security guarantees (where parents use their property as collateral) and servicing guarantees (where parents help with loan repayments using their income).
By providing additional security or income, a parental guarantee allows you to meet the lender's requirements without needing to pay LMI, which can save you thousands of dollars.
Yes, there are risks. If the borrower defaults, the parents property or income may be at risk. It’s important to consider these risks carefully before agreeing to provide a guarantee.
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