What are the pros and cons of the bank of mum and dad?

Many aspiring first-home buyers need help from the “bank of mum and dad” to purchase a home; but they should understand the commitment they are making before they proceed, a mortgage broker has warned.

Louisa Sanghera (pictured above), Zippy Financial director and principal broker, said most parents wanted to help their children achieve homeownership, but they must go into the agreement with both eyes open.

“According to recent research, about 40% of 25- to 34-year-olds expect to call on the ‘bank of mum and dad’ to achieve homeownership, with many likely to utilise a parental or family guarantee,” Sanghera said. “However, guarantees come with potential positives and negatives for both parties, which means everyone needs to understand the commitment they are undertaking.”

Sanghera, who is also the director of Mum CFOs of the Household, a platform to help educate women about money management and financial literacy, said parental or family guarantees have been becoming more popular over the years given the high price of property and the equity that many long-term property-owner mums and dads have in their homes.

“In essence, a parental or family guarantee is when a parent or family member uses the equity in their home as security against a loan taken out by their child or family member,” she said. “For example, if a mum or dad has $500,000 equity in their home, this equity can be used as security against their child’s mortgage. Of course, there are pros and cons with using this mortgage facility, which I always recommend everyone understands thoroughly before proceeding with this option.”

Below are the pros and cons of using parental or family guarantees when purchasing a home, according to Sanghera.

Pros

1. The borrower doesn’t require as big a deposit as they are using their family member’s property as security.
2. Using a parental or family guarantee can avoid or reduce the cost of lenders mortgage insurance.
3. There is no cost to the guarantor as long as the mortgage repayments are made.
4. Once the mortgagor has built up enough equity in their home or has paid off enough of the mortgage to get to an 80% LVR, the guarantor can be released from the agreement.

Cons

1. If the mortgagor defaults on their mortgage, the family member who acts as the guarantor is liable for the entire sum that they’ve promised to cover which is the amount over the 80% LVR.
2. The guarantor’s ability to take on further loans for themselves or for guaranteeing others is diminished during the guarantee period.
3. The guarantor may be putting their own home at risk if the mortgagor defaults on their home loan and they are unable to repay the initial sum guaranteed.

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