Property guarantees: parents can get kids into that first home

Property guarantees offer a way around the cash deposit barrier for many younger home buyers.

For many people the idea of parents providing a property guarantee to let the kids get started is now a live option.

The issue of home affordability is back on the front pages as house prices keep rising. An entire generation is left puzzled on how to fix a vexing issue: for many people the idea of parents providing a property guarantee to let the kids get started is now a live option … but is it for you?

Those in their 20s, 30s and even 40s have three basic options to try to crack the property market:

1. Make lifestyle compromises and gradually save a cash deposit. The problem with this approach is that due to rising house prices, the deposit required has sometimes been increasing quicker than their ability to save for it;

2. Accept that property home ownership is not achievable right now and instead focus on buying cheaper investment property while renting in desirable areas. The medium-term plan is to use the growth on their investment property to springboard back into the property market when they wish to buy a home.

3. Ask parents for a family guarantee to bypass the cash-deposit requirement to buy a family home now.

The maths behind why first-home buyers find it difficult to buy is simple to understand. Paradoxically, servicing a home loan is easy but getting the deposit together is hard. It is not uncommon for aspiring capital city homeowners to pay $600 a week in rent. Rent and other living costs make it a hard slog to save for a home deposit.

With banks offering variable home loan rates around 3.6 per cent, instead of paying $600 a week in rent, paying $600 a week into a home loan would result in a home-loan size of $570,000 if paying principal and interest over 30 years or $865,000 if paying interest only. Most first-home buyers would easily buy a home with this type of money but can’t, because they don’t have the deposit and the banks won’t lend.

Enter family guarantees: once they were relatively rare, now they are a regular part of conversations when it comes to buying a house. But it is important that parents and their offspring realise what a guarantee actually means.

Parental guarantees are a policy that most banks have to allow people who do not have the prescribed 20 per cent deposit to enter the property market by leveraging the wealth of their parents.

Credit adviser Elaine Lam from Elaine Financial specialises in helping people use minimum cash to buy their first home in Sydney. She says that she has seen banks focusing on the first-home buyer market lately.

Lam says “one bank has recently announced a policy that allows first-home buyers to borrow 100 per cent of the purchase price, plus borrow for the stamp duty and even borrow $50,000 on top for renovations. The banks have been focusing on how they can help first-home buyers get started with property as they witness falling housing affordability”.

HOW IT WORKS

The family guarantee works by allowing the borrower to buy their first home or investment property with little or no deposit on the basis that the borrower’s parent provides a financial guarantee. The guarantee is for the amount of money that the borrower is short compared with a normal lending situation.

For example, to buy a $1 million property, a borrower would usually need to save a $250,000 deposit. This would pay the 20 per cent deposit along with stamp duty and legal fees. If the borrower had only $50,000 in cash, the family guarantee would be for the difference of $200,000.

Lam says grandparents, uncles and aunties can also be considered as guarantors, however the banks generally prefer the guarantees to be given by parents.

The banks will take a charge over the parents’ home up to the amount of the guaranteed sum. Some banks will also consider a term deposit as a form of guarantee, however, the parents’ term deposit must be with the same bank providing the home loan to the children.

The main risk for the parents is that the children default on the loan and the bank demands any loan losses to be paid by the parents up to the amount of the guarantee.

Lam says that people should always shop around as “some banks do not charge a higher interest rate for loans involving a family guarantee, they can be approved at normal loan rates”.

Although baby boomers talk about how they managed with 20 per cent interest rates in the 90s, housing affordability is worse today than at any other time in history. For parents who can use some of their large paper gains from the property market to help their children get into the market, it can be a rewarding experience, however not without risks.

And one final tip, if you provide a family guarantee to one child, take a guess at what your other children will be asking you at the next family catch-up? So whatever you give to one child, you must provide for all.

James Gerrard is the principal and director of independently owned Sydney financial planning firm FinancialAdvisor.com.au