What is a family guarantee loan?
A family guarantee loan is where a family member – usually your parent(s) – uses equity in their property to help you purchase your new home. It’s a way to get into the property market without a large cash deposit and in some cases, you don’t need much in the way of savings at all.
A family guarantee loan allows you to avoid paying Lenders Mortgage Insurance, as the loan will be no more than 80% of the total security offered to the lender.
How does a family guarantee loan work?
The easiest way to explain how a family guarantee loan works is with an example.
Say you’ve found a property for $425,000, but you haven’t got much of a deposit saved.
A lender won’t allow you to borrow $425,000 using only your new property as security, because lending you 100% of the total security value presents them with an unacceptable risk.
So we have two options.
The first is to lower the amount you want to borrow. But this is a little hard if you don’t have enough in savings and you really want the house!
The second is to offer the lender more security, allowing you to borrow a higher loan amount.
Let’s go back to our example.
Purchase price is $425,000. If you were to borrow 80% of this value to avoid Lenders Mortgage Insurance, you would have a loan of $340,000.
But this leaves you $85,000 short, and we haven’t even considered the purchasing costs.*
Let’s say your parents own a property worth $500,000 and have no loans secured against it.
Sticking to our 80% Loan to Valuation Ratio (LVR), this means there’s $400,000 of available equity in your parents’ home ($500,000 x 80% = $400,000).
A portion of this available equity could be used to secure the additional $85,000 you need to purchase your new home.
Security offered for family guarantee loan:
Purchase Security Value (from new property): $425,000
Additional Security (from parent’s property): $106,250 – note this is only part of the equity available in your parent’s home
Total security offered for new new loan: $425,000 + $106,250 = $531,250
80% loan amount based on total security value offered: $531,250 x 80% = $425,000
By increasing the total value of security offered to the lender, you’ve been able to increase the loan amount to provide the funds you need buy the property.
I know what’s in it for me, but how does it impact my parents?
The guarantee provided by your parents is limited to the guarantee amount – in this example, it’s $85,000. Your parents are not required to hand over $85,000 cash to the lender, nor will they start making repayments on a new $85,000 loan.
What it means is that in the unlikely event you had issues with your loan repayments – and it got to the point where the lender needed to recover funds above what your own property property was worth at the time – if the guarantee was still in place, the lender would have every right to recover $85,000 from your parents.
A mortgage is established on your parents’ property as part of the family guarantee loan process. This means that whilst the guarantee is in place, your parents do lose flexibility in terms of what they can do with their property. So, if they have plans to sell in the next couple of years or release equity for other purposes, having a guarantee in place could affect these plans.
Does the limited guarantee stay there forever?
No. Not at all!
When your loan balance equals 80% of the value of your property, we can ask the lender to release the limited guarantee and solely use your property as security for your home loan.
How long it takes to get to this point really depends on how quickly you pay down your loan and (or) how quickly the value of your home goes up.
To ensure the guarantee doesn’t stay in place any longer than necessary, we can let you know when we suspect capital growth in your area as well as manage the release process with the lender.
Will a family guarantee loan work for my situation?
It depends on two things.
First, there needs to be enough equity in a property owned by your parents. If your parents have paid off their home and hold the title to their property, it can be a straight forward process. If your parents still have a loan against the property, there’s a bit more to the calculations, but it’s still absolutely do-able.
Second – and most importantly – your parents need to be open to the idea.
*To make things a bit simpler for illustrative purposes only, we have not factored in purchasing costs like stamp duty/conveyancing duty and we have assumed that any savings accumulated by the buyer in this example are sufficient to cover the purchasing costs involved. However, some lenders will lend enough funds to cover these purchasing costs too, meaning in specific cases – the borrower does not need to have any cash savings whatsoever.
Please note: Each individual has a unique financial situation and therefore any lending solution we may or may not propose is tailored to suit the individual needs of each client. We would need to conduct a Preliminary Assessment before we can recommend any particular loans or borrowing structure or provide credit advice of any kind. MO’R Mortgage Options is a Corporate Credit Representative (Credit Representative Number 487437) of BLSSA Pty Ltd (Australian Credit Licence Number 391237).
