This is a question that we, as trusted advisors, get presented with quite often.
This is becoming more prevalent as millennials appear to get priced out of the property market as they aspire to purchase their first home and parents are anxious to help where they can.
According to recent Westpac research, 6% of Baby Boomer parents have agreed to be a guarantor for their children’s home loans, while 10% have loaned funds and 12% made financial gifts. Further, according to this research, 25% of Baby Boomers liked the idea of going guarantor in the future, whilst 41% were willing to gift money and 35% were willing to loan the money.
As a general rule, we do not recommend that you act as guarantor for a loan or put your own home up as security for such a loan. This is because there is a possibility that you don’t clearly understand the extent and implications of the guarantee. This is despite the requirement that you seek legal advice before you execute any guarantee supporting a loan.
The harsh reality is that you can become liable for more than the original loan balance, should the loan fall into arrears or default in the future. There are many unforeseen circumstances that can occur in the future that could result in this, including relationship breakdown, death, physical or mental incapacity and loss of employment.
Such circumstances could see not only the home of your child being lost, but also your own home as your guarantee is called in should there be any shortfall.
The research indicates that a greater percentage of Baby Boomers were prepared to gift money rather than to facilitate a home purchase. However, we recommend that funds be lent rather than gifted and that the loan be supported by a simple loan agreement. Having such document in place will provide protection for the loan balance in the event of a relationship breakdown. In these circumstances, the loan balance would generally be a deduction from the borrowing couple’s asset pool in any subsequent property settlement. The formal signed loan agreement doesn’t need to have an interest component in it – but does provide a simple safeguard against a potential relationship breakdown.
In relation to business loans that you may be requested to go guarantor for – tread very carefully in these circumstances. At least if you go guarantor for a home loan, there will be a house to sell – and although there is a risk that you may be called upon to honour your guarantee, there is a tangible asset, being the house, to minimise the financial impact on you. In respect of a business, in many cases the biggest asset is purchased goodwill. If the business is run very badly, the value of goodwill can reduce quickly or even disappear, such there is nothing to sell to repay the debt. In these circumstances, your guarantee will most certainly be called in, resulting in financial loss, or worst case, bankruptcy to you.
In summary, if you are going to provide financial support for a family member, do it with a loan supported by a formal loan agreement. The loan can be gifted at a later time if you wish to do so.
As a last resort, after reading this blog post, if you are willing to go guarantor, ensure that the limit of the guarantee is clearly specified in the agreement. Avoid unlimited guarantees like the plague.
And finally, seek legal advice and clearly understand your obligations under any proposed guarantor arrangement.