House prices in Australia have cooled over the past 12 to 18 months attributed by a number of factors. A rigorous lending environment, the Royal Commission, talk of a change in government, change to foreign buyer policy, and a reduction in borrowing capacity for most (particularly investors). These factors have created uncertainty in the market and as you would expect, the media has gone to town feeding on it creating more fear. This storm will pass (as it has many times before) but like every market cycle, there are winners and there are losers.
The winners have been (and still are) first home buyers.
For first home buyers, the current property cycle is a dream come true as this group of buyers is finally getting their time in the sun as they are no longer being smashed at auctions by aggressive investors. Investors were the main source of competition for many first home buyers based on price point.
To give you an idea, as a share of all owner occupier commitments, first home buyers accounted for 17.9% in February 2018 compared to 13.3% the previous year (source: Corelogic). That’s a 35% increase..!!
When it comes to home loans, your bank (or lender) usually wants you to have some skin in the game, otherwise know as the deposit. For some first home buyers, saving a deposit can be a big challenge as their wages are typically lower and their household commitments can be higher if renting.
There is more than one way to skin the cat when it comes to raising the required deposit. Some first home buyers turn to family (typically mum and dad) for assistance. The great news is that a deposit doesn’t necessarily have to be in the form of cash, but can be via pledged equity from the family member.
A family pledge (family guarantee) is a type of guarantee that can be made to secure a property. This is done by security the deposit shortfall to a property owned by the guarantor. This type of guarantee is known as a guarantor home loan.
Like everything, there are pros and cons with family guarantees, so let’s take a closer look.
What are the pros?
- Access to finance: Most loans require a 20% deposit in order to be approved. A 20% deposit is favoured by most banks and lenders, however a deposit less than 20% is an option if you qualify for Lenders Mortgage Insurance. With a family guarantee you may be able to borrow more money and provide less of a deposit which will allow you to buy a home sooner.
- Avoid Lenders Mortgage Insurance (LMI): Borrowing more than 80% LVR usually requires you to take out LMI, but a family guarantee means this extra expense can be avoided. In my experiences LMI is usually in the thousands..
- Increased borrowing capacity: A family guarantee can boost your borrowing power. The family guarantee will often be used to cover a deposit that can’t be paid in cash so you will be able to borrow close to 100% of the loan. Often, guarantor borrowers can borrow 100% of the purchase price plus associated purchase costs.
- Eligibility for First Home Buyer benefits: Taking out a family pledge home loan means you are still eligible for financial assistance through government initiatives such as nil stamp duty, discounted stamp duty, and the First Home Owners Grant. Right now there are thousands of dollars in first home buyer benefits on the table.
- Limit your guarantee: While the traditional approach is to guarantee the full loan, in many cases you have the option of guaranteeing just a portion of the loan. For example, the guarantee portion is commonly for the 20% only (i.e. the point which removes the need for LMI). Once the standard LVR requirements of the loan product have been met due to loan repayments being made or a rise in the valuation of the home, the guarantee on the loan can be released by applying for a variation to the security held by the mortgagee.
What are the cons?
- Putting the family home at risk: If you’re the guarantor you could be putting your family home at risk, so consider all your options before choosing this approach. Legal advice is highly recommended to ensure you know all the risks associated with this strategy.
- Not receiving expert advice: If you’re considering applying for a family guarantee home loan, it is important that you, and the family member pledging their equity, seek out independent financial and legal advice first. You both need to understand exactly what the guarantor will be liable for in the event that you default on the loan.
- Not all banks offer family guarantees: Family pledge home loans aren’t offered by all lenders. In fact there are only a handful of lenders that offer this type of home loan product. The best person you can have in your corner as a first home buyer is a reputable mortgage broker or a mortgage specialist.
There are many different reasons a borrower chooses a family pledge home loan strategy. The most common I come across in my daily work are:
- No having adequate cash savings, and
- To save thousands in LMI
In closing, just like any sound finance strategy, understanding the risks and having an exit strategy is key to ensure that all parties are aware of their legal obligations and that the financial benefit outweighs the (perceived) risk(s) involved.
Disclaimer: This information does not take into account your individual objectives, financial situation and needs. You should assess whether the information is appropriate for you and seek specialist advice from a qualified and licensed advisor.