Property and Legal address the need for specialised, expert advice that is commercially viable and practical.

Family Pledge Loans: What do I need to know?

Since the COVID-19 Pandemic, property prices in Australia have jumped a staggering 13% with first home buyers facing an average purchase price of $678,236 in today’s market. These soaring prices, coupled with interest rates set to increase, make getting a foothold into the property market and buying your first home extremely difficult for the average first home buyer.

In the guise of assistance for the first home buyer, some banks have introduced new loan products such as the Family Pledge Loan whereby prospective buyers can purchase a home with the help of a guarantor – usually their parents, or a family member, or friend. This form of loan enables entry-level buyers to get approval for a property purchase without the minimum amount upfront, with a guarantor(s) providing security, usually in the form of a mortgage or second mortgage. In most cases, this guarantor’s “pledge” amount would be capped and agreed between all parties. The larger the capped amount the guarantor is willing to allow, the greater the amount that can be borrowed.

For most home buyers, the primary cost to be avoided is Lenders Mortgage Insurance, also known as ‘LMI’ which is not insignificant. Lenders Mortgage Insurance is Insurance that protects the lender should you default on your loan. The buyer will be expected to pay Lenders Mortgage Insurance when they borrow more than 80% of their home loan from their nominated lender. The cost of Lenders Mortgage Insurance will depend on the loan, your deposit, and the prospective lender you have chosen.

What are the advantages of a Family Pledge?

The primary advantage is that first home buyers will get access to purchasing a property they might not otherwise have been able to. In an ideal scenario, the new homeowners would then live in the property for a number of years and see its value increase to a point where the bank agrees to release the guarantor from their guarantee obligation.

What are the disadvantages of a Family Pledge?

Where things don’t go to plan however, a downturn in the property market could result in a price drop on the property purchased. In a worst-case scenario, the following example could play out.

Property prices drop, interest rates rise and one of the homeowners is unable to work or loses their job so are unable to make necessary loan repayments on their mortgage.

In a falling market where homeowners default, the bank is entitled to exercise their power of sale and sell the property. In this scenario, it is not inconceivable that the sale price would not be sufficient to repay the loan. Where this occurs, the homeowners will lose everything, and the bank will seek repayment of the shortfall of monies owing up to the capped amount from the guarantor(s).

In the event the guarantor(s) are unable to make the repayments quickly, this presents a real risk that the bank will be able to sell the guarantor(s) assets/property to recoup monies up to the capped amount, leaving the guarantor(s) with the balance of the sale proceeds. More significantly though, in this scenario it is often the parents or family who stand to lose their home in addition to the younger home buyers they supported to get into the market.

As you can see there is a significant divide between things going well, and things not going well.

Other Factors to Consider

What if the guarantor(s) want to sell their property and move? Will the bank be ready to agree to release and grant fresh security on the new property? What additional costs will be incurred?

Should the guarantor(s) be the prospective homeowner’s parents, what if they want or need to go to Retirement Village Living or an Aged Care Facility where mortgage security is not usually possible? To release the mortgage to sell, will they need to pay out the mortgage?

In a highly unpredictable market, and one seemingly vulnerable due to rapid and unsustainable increases, global economic impacts, and instability from so many contributing factors such as the increasing cost of building materials, a Family Pledge Loan may not be the most ideal loan.

Any property purchase is a significant investment and your first home is often driven by emotion. It is essential that you always seek legal and financial advice in order to protect your investment and choose a suitable loan that will not put yourself and others close to you at risk.