With Australian house prices continuing to surge in Sydney and Melbourne, saving for a deposit today is out of reach for many first home buyers. That is why the number of people using family members or friends to guarantee their home loans is rising. This means that more people are asking their parents to help them secure home loans by using their assets.
If you were to apply for a home loan today – but didn’t have enough money to meet the recommended 20% deposit on the loan – you may have considered asking someone for help in securing a home loan. You may also have had someone approach you about helping them out. Since 2010, the percentage of people who have had their home loan guaranteed by a family member or friend has risen by 1.9% to 6.7%.
This trend in loan guarantees is taking place because first time home buyers are competing in a fierce market. The pace of real estate growth is making home ownership too expensive for many people. Nationwide the real estate market is up 7% over the past year. Since 2008 the housing markets in Sydney and Melbourne have grown by 50%.
Surging Aussie house prices are making first home buyers a bigger risk for banks
Banks do lend to riskier buyers, but that usually comes attached with the pricey Lenders Mortgage Insurance (LMI), which banks use to shield themselves in case you default on a loan.
If you wanted to purchase a house valued at AU$400,000, you would normally need 20%, or AU$80,000, as a minimum deposit. But with LMI, you may only need as little as a 5% deposit (AU$20,000) to secure a home loan. If you had AU$20,000 saved up for a deposit, your LMI premium on a house worth AU$400,000 would come in at AU$13,000 (at an interest rate of 5%).
By using family members, people without the recommended 20% deposit are looking to secure a home loan without having to pay the costly mortgage insurance.
The risks you take in guaranteeing a loan for someone
If family members have approached you about securing their home loan, you need to consider the risks associated with this practice. The assets that you use to secure the loan – such as your home – are on the line for the loan you are guaranteeing. That means that if the person you are guaranteeing fails to make repayments on the loan, you will be responsible for paying back the loan amount, including any fees and charges that come attached.
That’s a lot of risk to take on. And you don’t get anything out of it. If the person pays off the loan, your credit record doesn’t change for the better. If they default on it, and you can’t pay back the loan, your credit record suffers.
In a worst case scenario, if you don’t have a title deed that proves you own the home that you used to guarantee someone’s loan, you could lose your home if you don’t repay the guaranteed loan in full. That’s not a situation you want to find yourself in.
What you can do instead of guaranteeing a loan
Have you considered how you would pay back the loan if your family member of friend suddenly couldn’t meet the home loan repayments anymore? There are ways you can help people close to you without guaranteeing their loan, and it will leave you in a better position if things take a turn for the worse.
One of the options available to you is to help by contributing to the deposit. Using the earlier example of a home valued at AU$400,000, you would be better off helping someone reach the recommended 20% deposit (AU$80,000) that eliminates LMI fees.
That way you aren’t using any assets to guarantee the loan, and you leave yourself with less risk attached. If the person you guaranteed defaults on their loan, you may have lost your contribution to the deposit, but at least you aren’t responsible for the entire loan. If you have cash assets, this may be the better route to go down.
If you don’t have cash to contribute to a deposit, you could explore the possibility of co-purchasing a house instead of guaranteeing a loan, which would at least give you split ownership of the property. That way you retain ownership of the house if your co-purchaser defaults on their commitments, and you’re not left solely responsible for a loan on a house you don’t own.
If you do decide to guarantee the loan for someone, you could also look into guaranteeing only part of the loan. Some banks are allowing this practice to help you limit your exposure to the risks of the loan. And if you used cash to guarantee part of the loan, you could also receive interest on your contributions. But you may want to use this option as a last resort if you want to protect your assets and eliminate any risk.
Mat Spasic
Contributor, Money Morning
The post Australian House Prices are High, but Should You Guarantee a Home Loan? appeared first on Stock Market News, Finance and Investments | Money Morning Australia.