Are you considering guaranteeing your child’s loan

Guaranteeing your child’s loan

Rising house prices and life changes are making it increasingly difficult to enter the market or take care of ourselves financially. Parents who guarantee their children’s loans can help, but it is important to understand how this can impact your retirement or investment plans.

Being a guarantor generally means using the equity in your own property as security for your child’s loan. It can help a first-home buyer to secure finance for a property they can afford but may not have a large enough deposit for, and to avoid the added cost of lenders mortgage insurance.

There are other advantages as well. By guaranteeing a loan you can help your child enter the property market sooner, and in a better location and in a property with a greater value, than if they do everything on their own. 

Understanding the risks

You may want to help your child but it’s important you don’t go into the transaction blindly. The main risk of guaranteeing the loan is that, depending on the structure of the guarantee, you could be liable should your child default on the payments, either by taking over the repayment schedule or handing over a full repayment.

If you can’t make the payments, the lender may sell the home used as security. If this is still not enough, the lender may also require you to sell assets to meet outstanding debt.

Another major risk is a bad credit rating if default occurs, and if you need to borrow money for another purpose, your property cannot be used, as the equity in your home is already tied up in your child’s loan,

Minimising the risk

There are ways to minimise the risks. The most common is using a monetary gift or private loan. This involves borrowing money against your property in your name, and then gifting it to your child, however, you should have a legal agreement in place. Another way to avoid the risk is to buy the property jointly with your child. This means your name is on the title and you have a certain percentage entitlement.

When it comes to guaranteeing a loan, it is always sensible to speak to a professional. You should also consider asking a legal professional to draw up a formal loan document outlining all conditions of the loan, interest rate and expected repayments.

Finally, agree an exit strategy. Financial situations change and, as the loan decreases with repayments, there may be an opportunity for you to withdraw your support to free up your assets without impacting your child’s loan. If you have any questions, please call us and we will help you get on the right track.