The latest case from the Royal Banking Commission is sure giving us a lot to talk about.
I’m referring to Carolyn Flanagan, a 67-year-old disability pensioner. She is legally blind and has suffered a stroke.
A few years ago, she put her home on the line to guarantee a $170,000 loan for her daughter to set up a business.
Two years later, the business had failed. The bank then moved to call up the mortgage guarantee and repossess her home.
Lucky for Ms. Flanagan, a solicitor from Legal Aid helped her get a lifetime tenancy deal. That is, she can stay in the home until she passes away. Only then will the bank repossess and sell the home to recover the loan.
Yet the case is putting the spotlight on guarantor loans.
That is, people (usually parents) allowing borrowers to use their equity or assets as collateral for a loan.
The truth is that things are tough for young Australians financially today.
It takes 12 times the median household income to buy a home. And, with stagnant salaries and higher costs of living saving for a deposit is difficult.
Meanwhile, baby boomers have seen the benefits from big property price increases. According to Corelogic, in the last 10 years Melbourne cumulative property values have increased by 72.4% and Sydney by 79.3%.
That’s why young Australians are looking at mum and dad to give them a leg up. They are looking to get help to get onto the property market, or a business loan for starting a business.
According to Digital Finance Analytics, the number of value loans made to first home buyers by the bank of mum and dad has increased to over $20 billion in the last years. This puts the bank of mum and dad among the top 10 lenders in Australia.
Source: Digital Finance Analytics
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And, who can blame them, right?
I mean, as Ms. Flanagan said in the enquiry, ‘If you can’t help your children, who can you help?’
While many get help in the form of a loan, or cash, others get help by acting as guarantor.
As guarantors, parents don’t hand out any money, unless the borrower defaults…
…and they take all the risks.
Being a Guarantor could ruin you financially
According to Mortgage Choice, only 4.9% of all first home buyers use a guarantor to buy property. Yet the number jumps up to 21.8% for buyers 29 years old and below.
I mean, guarantor loans are great way for children to get a leg up into the property market. Some brokers are even touting them as a ‘missed opportunity’ for buyers not using them.
But things can take a turn for the worse if there is a negative change in circumstances.
Things like your child losing their job or getting divorced could mean that they have a hard time keeping up with the payments.
And it can ruin your family financially if there is a downturn.
I have seen it before…
Guarantor loans were quite popular in Spain during the property bubble of 1997–2007. As property prices increased, parents helped their children get into property or start up a business by allowing them to use their assets or equity to back a loan.
It all came crashing down when property prices collapsed in 2007.
Unemployment soared…plenty of businesses went bankrupt…and it was impossible to sell a home at the high price they had bought.
Banks started to repossess assets and auction them at lower prices. You see, property prices had collapsed, so the auctioned property did not cover the debt the borrower had with the bank.
This left the borrowers with no property and a debt to repay. If there was a guarantor in the picture, it also left them with no home.
Guarantor loans can be a great way for your children to get onto property, but it can also mean financial ruin.
Look, all I am saying is, think about it very carefully before getting into one.
Property prices could fall 8% lower in 2018
There are no financial rewards for the guarantor, and there are plenty of risks. Especially in a declining property market, which could make selling a home tricky.
In Australia, lending conditions are tightening and lenders are starting to raise rates. We are already seeing the housing market slow in major cities.
Morgan Stanley is predicting property prices could fall by about 8% in 2018, and lending by more than a third.
Author and economist Harry Dent thinks property prices could fall even more. Harry is the editor of Harry Dent Daily and has been recently touring around Australia.
And, as he told Australian Property Investor recently, ‘the real estate bubble is like a popcorn popper with different markets frothing over and peaking at different times, but all will burst ultimately.’
As he said, we can consider ourselves lucky if the property market corrects by only 10–20%.
Stay tuned for more on Harry Dent and his worrying forecasts for Australia, next week.
Editor, Markets & Money