Helping your kids buy a home: what you need to know about being a parental guarantor 🏠
Written by Glen James
Host of the Retire Right & money money money (formerly my millennial money) podcasts & author of The Quick-Start Guide to Investing.
With property prices the way they are there are more and more younger Australians turning to the bank of mum and dad, often asking them to be a parental guarantor. But as a parent it can feel overwhelming or uncertain as to how guarantees work and how it will affect your finances. Will there be risk involved? Can you afford to do it?
These are very understandable questions, so today I wanted to share some guarantor basics. The below information is from Sort Your Property Out & Build Your Future, written by our property podcast host, John Pidgeon. Grab your kids a copy if it would help them prepare to get into the property market!
As a guarantor, you can help a family member secure a loan by using the equity in your home as security. This is a temporary arrangement where you don't need to provide any cash up front, but you must agree to take on the financial obligation alongside the borrower.
If the borrower defaults on their loan repayments, the lender has the right to sell the borrower's property. If the sale doesn't cover the full debt, the lender may then seek compensation from you, the guarantor, by using the limited value of your home provided as security. On paper, this could potentially lead to the sale of your property to recover the lender's money. But it's unlikely. Generally, the worst case scenario would be the amount owing would be put as a mortgage back on your home. This is actually a very low risk way to help your kids get into their home sooner. Just make sure your kids get income protection insurance, if they couldn't work. This will also lower the risk.
The equity you offer as security doesn’t have to cover the entire loan amount—just enough to help the borrower avoid Lenders Mortgage Insurance (LMI). Typically, this means keeping their loan-to-value ratio (LVR) below 80% and negotiating a limit on the amount you guarantee.
It's crucial that both you and the borrower seek specific legal advice before entering into a guarantor arrangement.
Let’s use an example to demonstrate how this works in real time. For the sake of simplicity, I’ve left out transaction costs.
Example
Your kids
Value of property they’d like to purchase: $600,000 ($120,000 deposit / security needed or 20%)
Their approved borrowing amount based on income (serviceability): $600,000
Their current deposit savings: $30,000 (5% deposit)
You as the guarantor
Value of your property: $900,000
Offered equity for your kids to use as security: $90,000 (15%)
If the borrower hasn't saved a 20% ($120,000) deposit and only has a 5% ($30,000) deposit, you, as the guarantor, would need to cover the remaining 15% ($90,000) by providing security through the equity in your property. This arrangement allows the borrower to secure the loan without paying LMI. This is not a cash transaction, it's security against your home.
Once the borrower’s property reaches an 80% loan-to-value ratio (LVR), you can be released from your guarantor obligations, allowing the borrower to manage the mortgage on their own. However, this release must be approved by the bank and confirmed in writing.
If you’d like to dive deeper into this, I made a video on this topic that may help break it down into more detail for you. Watch it here.
We work with a mortgage broker called Sphere Home Loans who work with a lot of podcast listeners all across Australia. If you would like to discuss your options, please reach out to them here.
I hope this has helped you, let me know if you have any further questions!
Community question
Peter asks: when our adult kids inherit our super do they have to pay tax on it? Thanks
Glen: Peter, in short yes, no and maybe.
It's safe to say there will be some tax paid to beneficiaries of superannuation that are not considered tax dependents. Tax dependents are children under age 18, a spouse/partner or someone who is financially dependent on you. Your superannuation account is made up of different tax elements. For example, your employer contributions that have had a tax concession (i.e. taxed at 15% when money is contributed, as opposed to your tax rate outside of super), will form part of the taxed element. Any money you contribute to superannuation from your own name and bank account, that has already been taxed by your employer, will form the tax-free element. This means, if an adult child who is a beneficiary of your superannuation fund received a payment upon your death, tax will need to be paid on the taxed element (not the tax-free element). A good rule of thumb is to allow 17% (of the taxed element). That is 15% plus the 2% Medicare levy. A worst-case scenario is 32%. Many people will have some legacy elements in their super funds from the times before major superannuation reforms, that's why I have mentioned the 32% worst case.
There are potential strategies that a financial adviser may employ to minimise tax to your adult kids. The taxes still remain, if it's inherited via your will. You can call your super fund and ask for the tax components, as these generally are not listed on statements.
If we can refer you to an adviser to discuss these kinds of matters, please reach out here.
