Buying and owning your own home has long been the Australian dream. It’s become somewhat of a rite of passage, ventured into as early as possible in your working life. It’s a dream however, that for today’s youth seems increasingly unattainable.

With property prices increasing and the average mortgage increasing in value (the NSW average is quoted as $407,000* and other states are not far behind), young adults are struggling to get their foot onto that property ladder. At the same time, many parents are finding their own homes have greatly increased in value.

These factors have helped contribute to an increase in loans involving parents agreeing to act as guarantor. Getting parents to guarantee a mortgage can provide big savings for their kids, often enabling first homebuyers to avoid substantial extra costs like mortgage insurance.

What is it that parents are guaranteeing?  Essentially, there are two main types of guarantee – a supported guarantee where the guarantor’s home or investment property is provided as security for the borrower’s home loan; and an unsupported guarantee, where the guarantor services the loan if the borrower is unable to meet the repayment schedule.

In today’s environment though, parents - in particular those who are older - need to be very careful about going guarantor. When the time comes for adult children to look at buying their first home, many parents are still in the accumulation phase of building their own wealth for retirement.  Having to pay their children’s mortgage could greatly interfere with their carefully laid retirement plans – at worst, it could even put their own home on the line.

It’s worth sitting down with your kids and doing the maths to check that they can handle the loan now and into the future. Remember, it only takes a slight rise in rates to cause some first homebuyers difficulty in servicing their mortgage. They should also be wary of any personal and lifestyle changes which could arise including starting a family, or becoming ill or injured, which would also impact on their ability to re-pay the loan. Above all, it’s important to ensure your children have realistic expectations of the type of home they can afford, even with your assistance, and the standard of living this will allow – living beyond their means will be the first step towards disaster.

Many banks and mortgage providers now offer products that present guarantors with only limited exposure should their  children default on the loan. There are also other, less risky ways that parents can assist - maybe lend  your children some funds for the deposit, consider a joint investment with them or perhaps allow them to live longer at home in order to save for a larger deposit.

In addition, some of the possible risks can be mitigated by appropriate insurance.  Increasingly, parents are funding income protection and life insurance premiums for their children as a means of ensuring the parents don’t end up having to bail them out if disability or death means the mortgage isn’t paid.  Premiums for younger people are relatively cheap and can help with peace of mind for all parties, including the banks.

Before signing on the dotted line as a guarantor, make sure you get some professional financial advice.  As parents, we want to help our children achieve their own great Australian property dream, however it is important to know where you stand and what your legal obligations are if you go guarantor. It’s too big a decision to leave to chance.

If you are considering going guarantor for a member of your family please consider legal advice as well as making an appointment with your adviser to discuss the potential impact it may have on your financial plan. 

• Source – www.lendingcentral.com.au - The average size of a new mortgage in Australia reaches record high (August 9, 2009)

Andrew Venning – Director, Advantage One