Just six years after bad lending practices fuelled the GFC, high-risk home loans are back on the market.
Plenty of lenders are offering low deposit loans. Indeed, one in three new home loan borrowers stump up less than the traditional 20% deposit these days.
One lender in fact offers a loan that, with the help of a guarantor, allows home buyers to borrow 120% of the property’s value.
As I see it, there are two key issues with these types of loans. The first is that the bigger your home loan, the more vulnerable you are to rising interest rates. That makes it critical to do the sums to see if your budget could cope if rates rose a few percent. As consumer group Choice notes, the average interest rate for standard home loans over the last 20 years has been 7.6% compared to 5.9% today
Having a big mortgage also makes it hard to cope if you lose your job or can’t work because of illness or injury. While this is a risk that can’t be ignored, for many first home buyers the squeeze often comes when a couple decides to start a family and one person has to take time out of the workforce – even if it’s for a short period. This can place a couple under significant financial stress – something no one wants to experience.
A second issue with low deposit loans is that they often call for a guarantor – usually a parent, who agrees to offer the equity in their own home as security for their adult child’s loan.
Under this arrangement, if the first home buyer runs into trouble, parents can be called on to make the repayments. Or in the worst case, they can be forced to sell their own home to make up the shortfall if their child’s home is repossessed by the lender. This is a very solid downside for ageing parents whose family home may be their biggest, in some cases their only, significant asset.
As a parent myself, I understand that we want to help out our kids. That’s a no-brainer. But if you are considering agreeing to act as a guarantor, it’s essential that you sit down with your children and do the sums to check out how well they would cope with any possible future rate hikes, or other changes to their work or lifestyle that may impact their ability to manage a mortgage.
It can be worth asking your child to take out income protection insurance. Or consider gifting part of the funds needed to buy a home or providing an interest-free loan if you have the financial ability to do so.
Speak with your solicitor to get independent advice about what being a guarantor will mean for you – and when your responsibility as a guarantor will end. You may be able to withdraw support if the property rises in value after the first few years.
Importantly, be honest with yourself about your child’s ability to manage a large mortgage. If a lender has questions marks about handing over a sizeable chunk of cash to your son or daughter, maybe you should too.