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Please Mum and Dad, can I borrow some equity?

Wednesday, 6th Mar 2013
Categories: Finance, Newsletter

mum and dad

There is a loan feature that allows a buyer’s family member to guarantee a portion of the loan, reducing the deposit needed or even eliminating the need for a deposit entirely.

For first time home buyers and investors, one of the biggest obstacles to buying a property is saving for a deposit.

There is however a way for buyers to get into their first property without a deposit by using what is called a family equity loan. In fact, it’s not technically a type of loan but rather a feature that can be added to most regular home loans.

This feature allows the buyer’s family member to guarantee a portion of the loan using existing property as security, reducing the deposit needed or even eliminating the need for a deposit entirely. The guarantor can be a parent, parent-in-law, step-parent or in some case even a grandparent or sibling.

The guarantor can determine what portion of the loan he or she will secure, but it’s normally in the realm of 20 per cent. The guarantor doesn’t need to actually provide the buyer with any cash or make any repayments on the loan.

It’s easy to see how this loan feature can help someone buy a home or invest in residential property sooner, because the buyer can effectively borrow the entire purchase price and costs. Plus, with the added security being provided, the lender may not require Lenders Mortgage Insurance (LMI), which can be costly for a borrower.

Some borrowers have used this feature not just to make a purchase but also to maximise the amount they can borrow and purchase a more expensive property.

Despite the lender having the extra security, the borrower will still need to meet the lender’s borrowing criteria, which may include having stable employment, a clear credit history, and an ability to service the debt.

In rare cases where the borrower defaults on the loan and the newly purchased property gets repossessed, there is a risk to the guarantor. If the sale of the property doesn’t generate enough money to repay the loan, the lender could demand the guarantor pay the shortfall up to the amount that was guaranteed. The good news is that once the borrower has built up enough equity in the property, the guarantor can be removed from the loan.