It’s common for parents to want to help their babies. When their babies are all grown up and looking to buy their own family home, a Family Pledge is one way they can help.
Family Pledge is also called; Security Guarantee, Limited Liability Guarantee, and Family Guarantee. It all sounds rather confusing, so let’s break it down.
When you buy a property, you get a loan from the bank. The amount of the loan is compared to the value of the property, this is what we call the Loan to Value Ratio (LVR). In most cases, when your LVR is above 80% you must pay Lenders Mortgage Insurance (LMI). LMI is an insurance policy that protects the bank in case you don’t pay your loan, and the sale of your property does not cover their loss.
- Purchase price $500,000
- Loan Amount $400,000 = LVR 80% (No LMI Payable)
- Loan Amount $450,000 = LVR 90% (LMI Payable)
Your parent/s may be able to use their property to provide the 20% deposit. The bank registers a mortgage against your parent’s property as well as yours. This can result in thousands of dollars of savings not paying LMI.
If you default on your mortgage, the bank has the right to take the 20% from your parent/s that provided the guarantee.
LET’S USE A SCENARIO TO SIMPLIFY IT FURTHER
Adam and Anne want to buy their first home together but don’t have the 20% saved up yet. They found a property for $500,000 and don’t want to miss out.
Adam’s parents, Bill and Brenda, own their home and want to help out but don’t have cash savings to gift to Adam and Anne.
Adam and Anne talk to their Mortgage Broker and find that they can get a loan of $500,000 through Z Bank. Z Bank will allow a Family Pledge, allowing Adam and Anne to borrow the full amount they need.
An application is approved for Adam and Anne for $500,000 which they use to buy their first home. Z Bank register a mortgage over this new home, plus a mortgage on Bill and Brenda’s home for a maximum of $100,000 (20% of $500k).
If Adam and Anne don’t make their repayments, Z Bank can take court action to sell Adam and Anne’s house, plus recoup up to $100k from Bill and Brenda.
Family Guarantees can be very complicated. It is important that you, and the guarantor/s, get sound advice and understand the risks and benefits.