February 8, 2014 by Ryan McLean 0 comments
I get a lot of questions from home buyers or investors about how they can take advantage of family pledge guarantor loans or how they can go ahead and purchase a property without a deposit or without their proven savings.
Today I sit down with Brad from Ocean Home Loans on the Gold Coast and we talk about what exactly is a family pledge guarantor loan , what are the benefits, and you’re putting up the guarantee them what are your rates/risks and what happens in worst case scenarios?
What Is A Family Pledge Guarantor Loan?
It can be referred to as no deposit home loan because you don’t have to come up with any funds yourself. It allows people who do not have a deposit or sufficient savings to purchase a property with the support of a family member.
Majority of lenders will keep this to either parents and siblings or in some cases grandparents. They tend not to extend this to aunts, uncles and other extended family members.
There are possibilities to it with your friends but it’s quite restricted. More than likely, if you are doing it with friends you’re doing something jointly as opposed to this is your own property.
In the past, when parents would go guarantor on the loan, it would mean that they were on the title and the mortgage as well. This is no longer the case.
Now you have a completely separate structured product where the children are the only people on the mortgage and the title. Which means that are still entitled to the relative states grants or boosts like (Queensland if you’re constructing). They would have been prohibited before, because of the parents who own the property would have been on the titles, but no longer.
How Is Guarantor Security Calculated?
Guarantors only offer partial security, or limited security on the mortgage.
The amount is calculated through a mathematical equation.
The way that works with the traditional loan is basically let’s a have a $500,000 property. The bank’s going to look for 20% deposit, which is $100,000 and so then your mortgage, would be $400,000 ($500,000 – $100,000 deposit).
But when you’re looking at security with the family guarantor loan it’s not going to work in exactly the same way.
What the bank does is actually increase the value of the debt security to make a 80% loan value ratio. Let me explain this in numbers because I find that the easiest way to do it.
Let’s say we have a $500,000 property, well that $500,000 is secured against your home. So therefore that’s a 100% LVR.
And now what the bank is going to do is then add security on top of that in order to get that loan value ratio down to 80%.
So rather than lowering the loan amount (from $500,000 to $400,000) because of the parent’s security – they are actually adding that security on top. The way to do it is to take your loan amount, let’s say %500,000 and we’re going to divide it by 80 because it’s going to count the 80%.
So 500,000 divided by 80, that gives us the value 1% and that is $6,250. What we do is then times by 100 to give us the full 100% and that’s going to equal $625,000. So we’re looking at a $500,000 property, if I’m the person buying and my parents are guarantors then I’ve got a debt security of $500,000 against my own property and then we need to reach that $625, 000 so my parents are going to have to add security of a $125,000 to that.
That brings the loan to value ratio down to 80%. It’s a little bit confusing, if you understand math really well then obviously it’s going to make sense to you, if you don’t then go ahead, speak to your mortgage broker or speak to your bank or your lender about this.
But basically divide by 80 whatever the purchase price for the loan amount is and then times by a hundred. So divide by 80, gives you 1%, times 100 gives you the full amount and then you minus your loan amount from that and that gives you the amount that your parents need to guarantor.
How Do You Go About Removing The Guarantor’s Security?
It’s not an automatic process, it’s a process that has to be requested. You can do it through your mortgage broker who will assist you with it or you can deal directly with your lender.
The guarantee can be removed any time but most people would wait until you have 20% of equity in the property. Either they’ve paid the loan down substantially over period of time or they had an increasing in property prices which means that the loan is now down to 80%.
Technically it can be removed any time as it meets bank policy for their maximum Loan to Value Ratio ratio. So if you’re prepared in the future to pay a mortgage insurance premium the you can pay the insurance policy and the bank will release the guarantee.
It is a process that you are going have to go through and request through mortgage
broker or through your lender. If the property goes up even if you get a new evaluation done they are not just going to remove the security unless you go through the credit process to have it removed?
You Should Always Seek Legal Advice
One essential thing is that the parents should take legal advice. I know they do it for the love of their children, but it is a large financial commitment so you should be completely aware of what your obligations are.
You are adding a mortgage to your property, maybe a second mortgage so you should take legal and financial advice.
So if things go pear shaped then you know the legal repercussions, you know what’s going to happen and so hopefully your relationship with your children is therefore protected.
Make Sure The Child Get’s Income Protection Insurance
Make sure you get income protection or your mortgage insurance protection your life insurance. It’s more likely something unfortunate will happen to you, rather than you simply losing your job and not being able to afford to pay the mortgage. So you want to protect against this.
Protect yourself, make sure you get your income protected especially when you are young. If property is where you want to invest and grow wealth fro then make sure you protect your income so you can continue to grow wealth.
Can Family Pledges Be Used For Investment Properties
Family pledges are for your own property, not for investing. So you cannot purchase an investment property using a family pledge loan.
However, you usually can live on the property for 12 months and the move out.
What Happens In Worst Case Scenario?
If the worst case scenario happens and for any reason the child is unable to pay the loan and the house goes into forclosure then the following things can happen.
1. Property sold – All mortgages released
If the property is sold and the bank gets all their money back then all mortgages and securities are released. So the guarantors do not need to worry in this situation.
2. Property sold – But loan not paid off
If the property is sold and bank does not get the full amount back then they have a mortgage on the parents property and they will be requesting those funds.
If the parents have any savings then the shortfall can be paid and if the parents have small loan amount they might be able to pay the mortgage repayments all by themselves.
So let’s say the property is sold that the child was in and it didn’t cover the mortgage the parents would then have the option to continue paying that mortgage until it was paid off or to release funds to pay the mortgage in full. They wouldn’t necessarily have to go ahead and sell their property straight away?
However, the amount that’s remaining then is a mortgage security, not a mortgage. Therefore the parents would actually have to apply for a mortgage – just like a normal loan application.
If they’re retired and can’t get service a loan, no bank is going to do much about that and therefore the may be forced to sell their property to release the funds.
The mortgage would never be automatically assigned to you because the mortgage is not your name. It’s assigned to your children so therefore there’s a change of hands.
The original mortgage is actually being discharged if you’ve sold the property. There is actually no mortgage, there is just a debt secured on the parents property which then needs to be…
So that is why the parents need to apply for a mortgage to cover that debt.
Worst Case Scenario Isn’t Always “Worst Case”
It’s good to know that worst case scenario isn’t necessarily your home is going to be sold automatically but obviously if you are retired and you don’t have any income coming in then you need to consider the fact that if things do go very pear shaped (which is rare) then you need to think about what that could mean for you.
Banks will not take on the family pledge from the parent who is heavily financially committed anyway is, they have to have quite a lot of equity.
The best thing would be to speak to your mortgage broker about whether you can actually do a family pledge and whether you will be approved for it because again, like Brad can look at 30 different lenders and say who does and who doesn’t rather that you just going into your bank and they say well we can’t service you but someone else might be able to.
If you liked what Brad had to say and you want to get his expertise for your specific situation you can get in contact with him through his website over at oceanhomeloans.com.au. Or view my other interview with him about increasing your borrowing capacity and the step by step guide to getting a mortgage.