In a climate where today’s younger generations are struggling to buy property, leveraging security from parents through a guarantee has become a common way to have sufficient assets available to acquire a loan. Unfortunately, there are complications that come with parents guaranteeing their children’s obligations that can have implications on the parents’ own finances as they move closer to retirement.
As a result, from 1 July 2019, the big banks have begun to impose new rules and assessment processes on prospective borrowers who are utilising this type of lending.
What is a Family Pledge Loan?
A Family Pledge Loan allows borrowers to secure the full value of the loan using the equity in their parents’ or family member’s property as security on the home loan. The bank will consider the loan application taking into account the relative’s residential real estate and the finances of the borrowers. Guarantors are limited to immediate family members, including parents, grandparents and siblings.
What can go wrong?
Guarantors need to be careful. Signing a guarantee can ensure their loved one gains approval for the loan, but the guarantor, together with the borrower, becomes responsible for the loan repayments, which may harm the guarantor’s financial position.
What are the new criteria?
Children looking to borrow money will face a greater amount of scrutiny into their ability to save money and pay off their loan.
Banks will now implement additional safeguards at the loan agreement stage. If the parents are guarantors, they will be warned about the risks of underwriting their children’s loans.
Guarantors will now typically be given a three-day ‘cooling-off’ period so as to minimise the pressure that may come from being asked to provide security for a loan to a family member. This provides the opportunity to assess the risk and to seek legal advice before signing any contract.
Guarantors will often be required to obtain independent legal advice and get a certificate from their lawyer acknowledging that they have received independent legal advice.
A Family Pledge Loan is an effective way for younger generations to acquire a loan, but it does come at a risk. Contact your trusted advisor to understand what your best decision is.