Aussies warned about risks of ‘Bank of Mum and Dad’

Young Aussies are turning to the ‘Bank of Mum and Dad’ to purchase a home, as house prices and the cost of living soar.

About 40 per cent of Aussies aged 25-34 expect to call on their parents’ help to purchase a property, according to a recent report by the Australian Housing and Urban Research Institute.

Parents may choose to gift their children money to help with a deposit, and/or act as a guarantor on the home loan.

Zippy Financial director and principal broker Louisa Sanghera said parental or family guarantees had increased in popularity given the high price of properties, along with the equity mums and dads have in their homes.

“In essence, a parental or family guarantee is when a parent or family member uses the equity in their home as security against a loan taken out by their child or family member,” Sanghera said.

“For example, if a mum or dad has $500,000 equity in their home, this equity can be used as security against their child’s mortgage.”

But both parents and their kids needed to understand the commitment they were undertaking, Sanghera said. Here are some of the benefits and risks.

Pros

  • Smaller deposit: The borrower won’t need as big a deposit if they are using their family member’s property as security for the loan
  • Avoid LMI: The borrower can potentially avoid paying lenders mortgage insurance (LMI), which is typically required for deposits that are less than 20 per cent
  • No cost to mum and dad: There is no cost to the guarantor, as long as the borrower always makes their repayments
  • It’s not forever: Once the borrower has built up enough equity in their home or has paid off enough of the mortgage to achieve an 80 per cent loan-to-value ratio, the guarantor can be released from the agreement

 

Cons

  • Mum and dad are liable: If the borrower defaults on their mortgage, the guarantor will be liable for the entire sum they have promised to cover
  • Impacts borrowing power: The guarantor’s ability to take on further loans for themselves or guaranteeing others (say other children) will be diminished during the guarantee period
  • Risking own home: The guarantor may also put their own home at risk if the borrower defaults on their mortgage and they are unable to repay the agreed sum

 

article from: au.finance.yahoo.com