Monday, 6 August 2012

Should I get a be a guarantor for my children so they can enter the property market?

A lot of parents wonder if they should go guarantor for their children so they can enter the property market.  This is not a decision that should be taken lightly as it links you and your financial future to your child for very long time.  The advice below is generic only and this is one time you really should have independent legal advice before you enter any financial decision.

One of the hard things about making this decision is that it is not a purely financial one.  Emotional factors are so much more influential than they normally are and I do not think it is possible to completely objective.  You should definitely have objective advice and this should not come from anyone that has a stake in the process (i.e. NOT your children, their spouses, other relatives, the bank or their attorneys).

The one thing you should realise up front is that you get no benefit from this arrangement.  It is your children that get the complete benefit and you are stuck with any downside.  With this in mind here are a few high level pros and cons for guaranteeing your children's debt so that they can enter the property market.

Benefits of going guarantor / having a guarantee
  1. It allows your children to enter the property market
    • In many countries property is still a very expensive proposition and many people struggle to save the deposit required to enter the market
    • Going guarantor means that you are using your credit worthiness and what you have worked for to enable your children to enter the market and get a foothold
  2. They avoid onerous costs such as lenders' mortgage insurance
    • In Australia if you borrow more than 80% of the property's value then you are due for Lenders' mortgage insurance which costs ~$10,000 and you never get this back in any form - it is a straight outflow
    • Lenders' mortgage insurance exists in some form in almost all jurisdictions
    • By going guarantor and using your own credit worthiness it implicitly reduces the LVR (assuming you have your own property) which means they do not have to pay this insurance cost
  3. Oftentimes the lower implied LVR will also mean lower borrowing costs
    • Interest rates are often tiered meaning that with the lower LVR your children will be paying a lower interest cost than they would otherwise be paying
Risks and downsides of going guarantor
  1. If for any reason they are unable to pay the loan you are 100% liable
    • If for any reason your children decide not to pay the loan (for example if you have a falling out, they lose their jobs, are taken ill etc) then you are completely liable for that loan
    • Everything you have worked for can evaporate very soon and you have absolutely no control over it
  2. Saving up for a deposit is a good indicator of your children being able to be financial mature and pay down their debt
    • The reality is that if your children cannot save up enough money to put down a deposit on a house (either because they do not earn enough or they are not sensible with their spending) then how on earth are they going to manage the responsibility of having a  home loan
    • You should encourage your children to save this deposit so they can do it themselves and give them any advice and lessons you learned along the way
  3. You are responsible for any increase in borrowings under the facility
    • Most guarantee agreements are not for a certain amount but rather over a whole facility (and occasionally extend to all borrowings by the guaranteed party).  This means that if you children draw down on the loan for any reason and sometimes if they take and even bigger loan you are liable for this even though you have not consented to it

Most parents are very keen to help their children enter the property market and their judgement is almost always clouded I would never recommend going guarantor for your children or anyone else. 

The most common argument is that they are your children and you have raised them correctly and they would never do anything to harm you financially.  However the number of law suits that deal with guarantors and parents losing their houses is truly staggering.  Falling out does occur often between parents and children and it is so much more complex if their are financial liabilities between you. 

While entering the housing market is a difficult task it is something that you should your encourage to do and perhaps give them advice or if you are so inclined you may consider giving them a small loan to help them along the way but giving a guarantee is almost always a bad idea.

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