Family Pledge Loans
A family pledge loan sees a guarantor, normally a parent, help a child buy either a first or subsequent home. This helps in two ways: the borrower doesn’t have to pay Lenders Mortgage Insurance (LMI) and they don’t have to spend years saving a large deposit.
Family pledge loans are also predominantly limited recourse for the guarantor. When the guarantor offers their property as security, they give a limited guarantee – so if the borrower only requires $30,000 to complete the purchase, the guarantor will only be liable for that portion of the debt. Subsequently, the bank will discount this debt with any proceeds of sale if the property is foreclosed upon.
The mechanics of a family pledge loan is as follows. If a child has saved $10,000 and is purchasing a first home for $400,000 with $13,000 in settlement costs, they will need $403,000 to complete the transaction. They are able to secure $320,000 (80%) against the purchase property and the remaining $83,000 would be guaranteed by the parent, but repaid by the child.
In scenarios such as above we normally see the child take the debt against the purchase property as interest only given the size of the guarantee. Over the course of the 5 year interest only period they pay as much of the guarantee portion off and hopefully their house has appreciated in value over that time. If they can pay $43,000 off the guarantee over the 5 year interest only period and their house is worth $450,000, they should be able to release an additional $40,000 against their home and discharge the guarantee.