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Parents thinking of going guarantor for their child’s mortgage are being warned to be careful as property prices continue to fall and interest rates continue to rise, increasing the risks for those guaranteeing the mortgage of first home buyers with small deposits.
Prices, nationally, are down almost 10 per cent from their peak in early 2022, with most property experts warning prices could fall by up to another 10 per cent from here.
Those first-time buyers who put down a small deposit risk being in negative equity – where their property is worth less than the mortgage. While the unemployment rate is very low, some economists have raised the spectre of recession, which would see the jobless rate rise.
Parents thinking of going guarantor for their child’s mortgage are being warned to be careful.Credit:Peter Rae
The pessimistic tone on the economy follows the Reserve Bank increasing the cash rate by a quarter of a percentage point last week. The RBA flagged further rate rises, saying it would do whatever it takes to bring inflation down.
Fiona Guthrie, the chief executive of Financial Counselling Australia, says it is “important to understand that if the person you are guaranteeing does not pay the loan, you have a legal obligation to do so instead.”
She says the person wanting the guarantee will usually have an emotional or family connection to the borrower and if things go wrong, those close ties can be put at risk along with the financial implications for the guarantor.
It is important to get independent legal advice before you become a guarantor, and those involved should be fully informed before agreeing, says Prue Monument, the chief executive of the Banking Code Compliance Committee (BCCC).
“Ensuring you are clear about what you are signing up for in agreeing to guarantee a loan is essential because of the large financial risks involved,” Monument says.
“It’s also important that people don’t feel pressured into going guarantor; in the worst cases, this can amount to financial exploitation, or what’s known as elder financial abuse,” she says.
The BCCC monitors banks’ compliance with the Banking Code of Practice, which includes obligations to ensure customers make fully informed decisions before agreeing to be a guarantor.
The committee is undertaking a follow-up enquiry on banks’ loan guarantee practices after its 2021 review on the same topic found banks failed to consistently provide full disclosure of key information to guarantors, among other failures.
The Australian Securities & Investments Commission’s MoneySmart site says guarantors who put up their house as security must understand that if the borrower defaults on the loan, the lender may sell the house to pay the debt.
It also says that if the guarantor applies for a loan in the future, the fact they are a guarantor will have to be disclosed to the lender, which could affect the guarantor’s ability to get credit.
AMP financial planner Andrew Heaven from WealthPartners Financial Solutions says his clients include those who are considering becoming a guarantor for their child’s mortgage.
He says many are currently thinking that while interest rates are rising, property prices are falling and it could be a good time to get onto the property ladder.
“As a financial planner, I am not there to be a cheerleader for what they want to do, but to make sure they are making informed decisions, taking into consideration their individual circumstances,” he says.
“If a lender requires them to go guarantor, they should ask themselves why,” Heaven says. “I point out to them that their kids have many more pay packets ahead of them than they do.”
It is often the case that a lender requires a parent to be a guarantor not because the child’s cash flow is poor but rather that the child has too small a deposit, Heaven says.
Instead, parents could supplement their child’s income to help the child save for a larger deposit. “You can gift your child money, as long as you are very aware that it is not coming back”, he says.
He says the federal government’s Home Guarantee Scheme, where qualifying first-home buyers need a deposit of only 5 per cent, is worth looking at; though places in the scheme are limited.
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