‘Bank of mum and dad’ boom – and the risks of being guarantor if house prices fall 🏘️💸
As house prices rose over 20% in 2021, the fastest lift in more than 30 years, a growing cohort or people aged in their 20s to 40s who make up today’s generation of aspiring property buyers feel resentment towards the baby boomers – who are selling their homes in record high prices. Part of this is because the 1980s had an average house price under $300,000 in Sydney and under $200,000 in Melbourne.
But alas, the younger generation has no recollection of the 17 percent interest rates or of the recession we had to have. If interest rates today were 17 percent, the average home loan repayment in Sydney would be more than $13,000 per month.
So this increasingly frustrated generation is becoming desperate and often turning to their parents to help crack the market. However, parents and their children potentially don’t appreciate the risks involved with borrowing so much money, including being a guarantor to the property. This occurs when the child does not have a sufficient cash deposit to get into the property market, so the parent(s) provide a guarantee to the bank in lieu of the child providing cash.
A family guarantee sounds great and can work well when the property market is rising. The child is able to buy a home with no deposit, and as the property rises in value, they can refinance the debt and release their parents when they have enough equity to stand on their own feet. But what if we are heading towards a peak in prices, or even a period of little or no growth?
A family guarantee could turn out to be a disaster if property prices fall. Many mortgage brokers do not recommend family guarantees, and especially not in the current market as the risks are very high.
What could happen with a family guarantee if property prices fall?
Having wafer-thin equity in a property is risky. Most banks have clauses written into their loan agreements that allow them to review the borrower’s circumstances. If they fin that here is negative equity, they are well within their rights to request the borrower take action to remedy the situation.
The result is that the bank may ask the parents for a larger guarantee over more property assets or request cash to pay down the child’s mortgage if the child doesn’t have the cash.
In some cases, the bank may wind up the loan and require the child to refinance to another bank, or pay out the loan, which could trigger a fire sale.
Many home buyers relying on family guarantees are unlikely to have sufficient cash buffers for situations like this. So the bigger the mortgage the higher the likelihood of financial distress if the unexpected occurs.
The parents providing the guarantee also need to think carefully about what they are getting themselves into. The bank may only request a signed written guarantee stating that if the property is old and there is a shortfall, they are liable to pay the shortfall to the bank.
But in other cases where the bank wants a higher level of assurance, they may place a caveat or take out a mortgage over the parents’ property, which can affect their own finance.
Bank of Mum and Dad is the nation’s ninth largest mortgage lender
Accounting for $29 billion annually, Bank of Mum and Dad (BoMaD) is the nation’s ninth-largest mortgage lender and a port of call for almost 4000 “kidults” every month, according to comparison site Finder.
While it’s natural for parents and grandparents to offer what they can, housing specialist Martin North is not sure in this case it’s always good thing. His company, Digital Finance Analytics, conducts a rolling national household survey which has tracked the massive spike in BoMaD borrowing.
He says the average loan is a whopping $90,000 but that’s not the real concern. It’s the fact that adult children who borrow from parents are three-to-five times more likely to default on their mortgage within five years.
“The trouble is that those who have not had the discipline of saving over many years for a deposit can find that when they are given that seagull payment, they probably buy a bigger property than they should.”
That means taking on a bigger mortgage than they should without having learned the discipline of managing their finances.
Tougher terms on guarantors by banks
With the housing market at all time house, and many experts predicting slower growth – many lenders have been rolling out tougher terms in response to the Banking Code of Practice that was introduced at the end of last June.
For example, NAB loan guarantors face closer scrutiny of their suitability, by being required to provide information about how it will impact their finances and their awareness of their potential liability if things go wrong.
That means guarantors need to obtain legal advice, or provide evidence that they have reviewed the documentation setting out terms and conditions.
CBA says it also assesses the job, or income, of the guarantor and will not accept their principal place of residence as security if the majority of their income comes from a pension.
In addition, lenders offering the cheapest rates are typically also imposing much higher loan to value ratios, usually around 70 per cent, rather than the 80 per cent that most lenders require.
“With recession comes heightened risk awareness on the part of home lenders, who will be placing a tighter ruler over income security in assessing loans,” says Steve Mickenbecker, group executive for Canstar, which monitors fees and rates.
Westpac Group has recently introduced changes to its family pledge policy requiring evidence of any existing liabilities secured by the guarantee security property at the time the application is being assessed.
Today’s generation seems less willing than previous generations to start small and go up from there, like you would in a game of monopoly.
Put simply, if you can’t afford to buy where you want to live, buy what you can afford to buy. Otherwise, if your a parent and become a guarantor on the property because your child wants to start big, you may find yourself stuck holding large debt – which will become a nightmare should the market stagnate or fall.
And if you are considering being the guarantor on your child’s property, it’s strongly recommended to discuss this with an independent mortgage broker.
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