Security Guarantees to support family in Purchasing Property
In the post-pandemic era, 'The Bank of Mum and Dad' is funding around $34 billion in loans or 60% of first-home buyers. In 2021, this made parents Australia's ninth-largest residential mortgage lender - bigger than the likes of HSBC, AMP and Bank of Queensland.*
In this article, we outline how family members can provide "security" or "collateral" generally in the form of a residential property. Typically called a Family Security Guarantee, or similar, it is distinct from an Income Guarantee, which supports the borrowers in making ongoing loan commitments.
Under the arrangement, a family member serves as a guarantor for another. Commonly, the security or collateral required by a lender from a guarantor is a low mortgage or mortgage-free residential property.
Who can be a family member?
Anyone who passes the standard requirements can become a security guarantor for other family members. Looking beyond mum and dad, sometimes other family members such as grandparents and siblings may offer to provide guarantor support. Adult children may also be guarantors to their parents in some instances.
Using cash as security?
Some lenders allow for the security guarantee to be held against a cash term deposit. The term deposit is established and will continue to roll over until the required Loan-to-Value Ratio or LVR is achieved, usually 20%. Then, the guarantee can be released.
A Family Security Guarantee cannot be used for debt consolidation, owner-builder construction, cash out, or adding a security guarantee to an existing loan.
Ways a family security guarantee can aid borrowers?
The first hurdle for first-home buyers or those looking to upsize to a second home is saving a sizeable deposit. Often, lenders require an additional loan mortgage insurance fee when deposits are below 20% of the loan value. The LVR is a percentage determined by dividing the loan amount by the property's value or purchase price.
In practical terms, the bigger the deposit, the lower the LVR, therefore increasing the likelihood of a loan approval along with other terms, such as interest rates.
How a Security Guarantee works
Let's look at two common ways a security guarantee is utilised between family members. Firstly to save on Lender's Mortgage Insurance and reduce upfront costs. Secondly, to make it easier to buy a property that is outside of the borrower's range.
1. Saving on Lenders' Mortgage Insurance (LMI)
In some circumstances, several lenders have recently waived the need for income details or statement of position information from the guarantor when the funds go towards removing LMI. Consider this scenario:
Sam and Jo have found an ideal home in Victoria with a purchase price of $750,000.
They have a deposit saved of $90,000 and have sufficient income to service the loan. However, the lender advises that since the LVR exceeds 80%, LMI will be required, as shown below:
| SAM & JO'S PROPERTY PURCHASE: | AMOUNT |
| Purchase Price | $750,000 |
| Cash Deposit | $90,000 |
| Additional "Security" Value | n/a |
| Initial Loan Amount | $660,000 |
| Loan to Value Ration (LVR) | 88.0% |
| Indicative LMI Premium^ | $17,000 |
| Stamp Duty | $31,070 |
| Legal Costs | $1,500 |
| Other Upfront Costs | $49,570 |
^LMI is typically financed of the loan term.
After receiving the independent advice, Sam's parents provide a Security Guarantee of $97,500 against their mortgage-free home to effectively boost the deposit contribution. The LVR is lowered below 80% and removes the need for LMI as below:
| SAM & JO'S PROPERTY PURCHASE: | AMOUNT |
| Purchase Price | $750,000 |
| Cash Deposit | $90,000 |
| Additional "Security" Value | $97,500 |
| Initial Loan Amount | $660,000 |
| Loan to Value Ration (LVR) | 77.9% |
| Indicative LMI Premium^ | $0 |
| Stamp Duty | $31,070 |
| Legal Costs | $1,500 |
| Other Upfront Costs | $32,570 |
Sam and Jo proceed to purchase the property. Once the loan amount is reduced to an LVR of 80% or below, the guarantee against Sam's parents' home can be released.
2. Boosting equity contribution to purchase the next home
A security guarantee can help family members buy a home by increasing the size of the deposit available to use to obtain a loan. In most cases, a single guarantee can represent no more than 50% of the loan guarantor's security.
Eight years later, Sam and Jo decide to buy a much larger home in a high-demand suburb. The previous guarantee with Sam's parents has been released on their existing property. After selling their home, Sam and Jo have savings of $250,000 to use for a deposit (allowing additional funds for stamp duty and legal fees).
Jo's older sister Holly offers to provide a security guarantee to boost their deposit to 20% for their next property.
Holly's property is valued at $800,000. However, she already has a mortgage of $250,000 and can only leverage up to 50% of her property as a guarantor.
Sam and Jo's mortgage broker secures a guarantee of up to $202,500, which gives them a possible deposit of $452,500.
The pair find the ideal property for $2.2 million which requires a deposit of $440,000. Sam and Jo use $250,000 of their deposit funds and a security guarantee against Holly's property of $190,000.
Pros and Cons of Family Security Guarantees:
Pros
- It is a good way to help the borrower save on LMI costs.
- Initial liability of debt falls on borrowers, not guarantors.
- Once the borrower's home equity reaches 20%, the guarantor can be released from the mortgage, rather than when the loan is fully repaid.
Cons
- If the borrower stops paying the loan, the guarantor will need to make the repayments on their portion of the loan.
- If the loan defaults, the lender has the right to sell the property that is being held as security.
- The borrowing capacity of the guaranteeing family member may be reduced.
- Additional costs, such as stamp duty and legal fees, still need to be factored in by the borrower.
- A family security guarantee is a serious commitment that requires independent financial and legal advice. When family relationships break down or become complicated, a clearly defined and legally binding arrangement can protect all concerned.
Other financial support options?
Using Security Guarantees to purchase property is an option that does not suit all families. Other ways that families can explore to assist with buying a property include co-borrowing, offering monetary loans and monetary gifts.
To help others save a property deposit, family members often assist with rent-free or subsidised accommodation, support with childcare and supplemented expenses such as group mobile phone plans.
In addition, providing family members with access to financial planning, budgeting tools, and other financial education can create long-term generational benefits.
Further Recommended Reading:
ANZ: How a guarantor could help you buy your property sooner | ANZ
Westpac: Guarantors and the Family Security Guarantee | Westpac
CommBank: Guarantor Guide
Property Planning Australia Security guarantees, co-borrowing, gifts and more - Helping your kids buy their first property (Ep.95) - Property Planning Australia
Morrows Accountants The Bank of Mum and Dad: Tips for Parents Lending Money to Children - Morrows Corporate
*Source: 2021 analysis by researcher Digital Finance Analytics (DFA).
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The team at MCP Financial Services has specialised expertise in structuring complex debt arrangements. We can assist with review and restructuring, refinancing and renegotiating.