You want to help your kids get onto the property ladder – because houses are expensive, and banks are increasingly picky about lending.
Your guarantee could make all the difference for a child who hasn’t saved a 20 per cent deposit.
Yes, you can use your equity to help them, so you don’t even need to front up with any cash, writes Amy Hamilton Chadwick. But it’s a case of ‘guarantor beware’.
The ’Bank of Mum and Dad’ is busier than ever
Across New Zealand it’s estimated that 50 per cent of first-time buyers need some kind of help. This help may be someone acting as a guarantor, a gift of money, or a loan – and of those three options, being a guarantor is the one Templeton likes least.
“I don’t encourage parents to be guarantors,” she says.
“People suggest it flippantly, but it’s a big concern. Talk about what could happen in real life when you’re getting a mortgage – don’t just take the money and run.”
Being a guarantor means you are jointly and severally liable for the whole amount of the loan.
Become a guarantor and the bank may well allow your child to buy a house worth, say, NZ$650,000 with a 10 per cent deposit rather than the usual 20 per cent. In your mind, you’re merely bridging that gap: NZ$65,000.
But if your child can’t pay the mortgage, the bank can come after you, not just for the 10 per cent shortfall, but also the remaining NZ$520,000. The banks go after the easiest target – that’s not going to be your child’s income, it will be your equity.
“Parents could be put in a dire situation,” says Templeton. “The bank could demand the equity of their house to settle an outstanding debt if it all turns to custard.”
She knows a woman in her 70s who guaranteed a child’s loan. When the bank foreclosed, she lost her own home and was forced to rent in her retirement years.
Lend or gift, instead of guaranteeing
You may be better off gifting or loaning your child the deposit shortfall, says Templeton. You won’t then be responsible for the mortgage repayments, so your risk is tightly controlled.
Gifts are the most common form of parental help, with some parents working out agreements that keep the finances fair. For instance, parents may gift NZ$50,000 to one child, with a condition that the same amount is subtracted from that child’s inheritance.
Loans allow parents to have a reasonable expectation of getting their money back; interest-free loans can be a solid compromise. Some forms of bridge loans let you limit your risk to only a deposit loan, not the full principal balance.
If you are going to be a guarantor, try to protect yourself
Before you guarantee a loan, ask yourself a few questions:
· Is my child trustworthy and likely to repay the loan?
· Is my child’s partner also trustworthy? If they split up, how will the loan be dealt with?
· Am I helping cover a deposit shortfall, or am I paying part of the mortgage, too? If your child doesn’t have the income to service the debt, how long will you be paying it off? Is it going to cut into your retirement? If you’re covering a percentage of repayments as well as guaranteeing the loan, Templeton recommends you seek legal advice and draw up a property share agreement, stating clearly who is paying for what, with an exit clause.
· Can you limit your liability?
· Do you have other assets that can be offered as security for the loan, rather than your home?
· Can you afford to pay the whole loan if your child defaults?
· What is the exit strategy – when will you stop being the guarantor?
Bridging the gap to a deposit is one thing; setting your child up with a mortgage he or she can’t pay could result in problems for you and them.
“It’s great to help your kids onto the ladder, but you don’t want to help them fall off by going one rung too far,” Templeton says.
“If you’re helping them to extend themselves beyond what they can afford, I would question whether that was doing them any favours.”
Ideally, you’ll have been having realistic conversations about money with your children – you need to explain your long-term financial strategy and your need to protect your retirement.
Together you can talk to a mortgage adviser about other options, but don’t allow yourself to be talked into an agreement that could cost you your financial security.
First published 29 June, 2018
Story by Amy Hamilton Chadwick
JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions. This story reflects the views of the contributor only. Content comes from sources that JUNO considers accurate, but we do not guarantee that the content is accurate.