Bank of mum and dad can take a hit

Helping your children buy their first home can come back to bite.

Lending money for a deposit or guaranteeing their loan can break families apart and lead to parental bankruptcy unless everyone goes in with their eyes open.

The risks of gifts

Gifting the deposit is one of the ways parents help. Lending the money, however, may be safer. Parents often don’t think of the consequences of their action. What happens, for example:

• If your child splits from his or her partner? Half of your gift might go to the now less than favourable former partner.
  
• If your child develops an expectation you’ll shell out money whenever they want it?
  
• If the other children become bitter and twisted that their sibling got more than they did?
  
• With your Will? Do you take this money into account when divvying up your wealth?
  

Some parents borrow themselves in order to fund a deposit for the children. Banks are wary of this and may not lend if they see the child didn’t save the deposit money themselves.

If the child subsequently loses the home, the parents are still stuck paying the loan they took out.

More than a piece of paper

If you don’t have cash to lend to the children, but still want to help, another option is to go guarantor. That means you guarantee that if the child can’t repay the loan, you will.

Banking Ombudsman Nicola Sladden says parents don’t always understand the implications of this. It’s much more than a piece of paper that you’ve signed.

“Parents are frequently unaware of how a guarantee works in practice. The amount of a guarantee is often unlimited. Even if it is limited to the amount of the loan, it is often a guarantee of all the customer’s borrowing up to that limit, not simply of the original home loan.”

This means parents are accepting legal liability for other debts incurred in their name, irrespective of whether those debts were incurred before or after they provided the guarantee.

That’s a very good reason to get legal advice and use a mortgage broker who may be able to negotiate a more limited guarantee.

Many a parent has been caught by their kids behaving badly.

“It is natural for parents to assume that they know their child’s credit history, their likelihood of making repayments and whether they will be clear and transparent about the borrowing,” Sladden says. “But this is not always the case.”

It can lead to severe relationship breakdowns if a guarantor is actually called upon to pay the loan.

“The fact a bank requires a guarantor means that the borrower did not meet the bank’s lending criteria or that the borrower may default on the loan,” says Sladden.

Impossible to cancel

When parents realise the extent of what they’ve signed up for, they sometimes try to cancel the guarantee. It’s not so easy and does not absolve the guarantor of all responsibility.” says Sladden. “They will still be liable for debt incurred right up to that point in time.”

If a parent does cancel a guarantee, the child may then struggle to continue borrowing finance from the bank.

Another fish-hook in the three-way guarantor relationship between parent, child and the bank is that, when things go wrong, there is no obligation for the bank to pursue the child for the debt first. The bank can just go straight to the guarantor for money.

If the parents can’t come up with cash to pay, the bank can force the sale of their home if it’s easier to sell than the child’s.

If a guarantor has an account at the same bank as the borrower,” says Sladden, “the bank may take funds from the guarantor's account to cover the debt.”