Guarantors go out on a limb to get their children on to the ladder

With unemployment rising and house prices falling, parents have to be more cautious about underwriting mortgage repayments, writes Laura Howard
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The Independent Online

Traditionally, there is nothing unusual about parents lending a hand to their children when they want to buy their first home. But if the help comes in the form of a guarantor mortgage, they would do well to tread carefully. The economic backdrop of falling house prices and rising unemployment is putting their own borrowing capacities, credit records – and even their homes – at risk.

A guarantor mortgage allows a parent or close relative to use their income to enhance the amount the child can borrow. According to financial information provider Moneyfacts, only three lenders, including the Catholic Building Society, still offer specific guarantor deals. "But a whole raft of banks may accommodate guarantors within their standard underwriting process," says Moneyfacts' mortgage expert, Darren Cook.

Despite a 15 per cent drop in house prices during the past year, lack of affordability is still afflicts many first-time buyers who have also been hit with larger deposit requirements, says Melanie Bien, director of mortgage broker Savills Private Finance. "Borrowers will now need to raise at least 10 per cent of the property value, so while the guarantor element is an added reassurance for the lender, the deal will still only be agreed if there is a big enough deposit."

A guarantor loan is designed as a halfway house between the child buying alone and taking a joint mortgage. While parents will have to sign a legal document declaring that they are a backstop if payments are not met, their names won't actually feature on the mortgage agreement. Because of this, they don't have to be recorded on the property deeds either, which gives independence and responsibility to their offspring. But most importantly, the arrangement sidesteps any capital gains tax liabilities as the parents will not own even part of a second home.

However, the added reassurance that guarantors provide to the lender will still have to be financially quantified. For the vast majority of banks and building societies, this means parents should be able to demonstrate they could qualify for the entire mortgage. But this can be tough as their existing liabilities, such as their own mortgage, are taken into account, says Andrew Montlake, a partner at broker Cobalt Capital.

"For example, if the parents' joint salary is £100,000 a year and the lender's income multiple is four times this, they could borrow £400,000. But take off their outstanding mortgage of, say, £250,000 and they can only borrow £150,000."

Skipton building society is the only lender that looks for the shortfall on the mortgage to be covered by parents' income multiples. So if a child qualified for a £100,000 mortgage on a £200,000 property, the parents would need to show they could qualify for the remaining £80,000 loan (taking into account a 10 per cent deposit.) "But we will still look at the parents' existing liabilities and check they would be able to service the full repayments if they had to," says Skipton's head of lending, Colin Dale.

Being registered as a guarantor with any lender will affect parents' ability to borrow should they want to trade up the property ladder or even take a further advance, says Mr Montlake. "This is why, if they act as guarantors, they should consider it the same as taking another joint mortgage."

The real problems start, though, if the children find they can no longer service the loans – in the event of losing their jobs, say. According to a recent report from the CBI, this is now a real threat. The employers' organisation found that unemployment could peak at close to 2.9 million by 2010.

"Just because the child is earning and making the mortgage repayments now, does not mean this will always be the case," warns Mr Montlake. "If they lose their job, the mortgage still has to be paid, and while the lender will chase the child first, ultimately the guarantors are liable for the entire loan."

Furthermore, as lending criteria tighten, many banks now also require "supporting security" from the guarantor, says Mr Cook at Moneyfacts. So if the child defaults on the loan, the parents' own home, as well as their credit rating, is at risk. But there are lots of opportunities to recover before this point, says Ray Boulger, senior technical manager at broker John Charcol. These include taking in a lodger and even selling the home.

However, the latter solution relies on staying out of negative equity, and earlier this month Citigroup analysts predicted that three million UK households could slip into just this position as a result of falling house prices.

Yet Bank of Ireland's guarantor scheme, called 1st Start, still lends up to 95 per cent loan to value (LTV). This means that if a borrower puts down the minimum deposit, house prices only need to fall another 5 per cent before they are in negative equity.

However, because 1st Start works on a full joint-mortgage basis – rather than just a guarantor one – it provides extra security for the bank and makes for some competitive pricing, says Mr Boulger. "Currently, a three-year, fixed rate is priced at 6.55 per cent. At 95 per cent LTV, with no arrangement fee or higher lending charge, this represents excellent value."

But with any guarantor deal, some sort of insurance is vital, says Matt Morris at independent adviser Lifesearch. "Rather than just taking payment protection insurance (PPI), borrowers should look at income protection, which is more affordable and comprehensive. It also comes with unemployment cover, so ultimately it would safeguard their payments."

Even with insurance in place, no guarantor scheme should be taken lightly, says Ms Bien "This is a huge financial commitment, particularly when unemployment is rising. Parents should therefore seek legal advice before committing themselves."

But Helen Adams at housing advice site FirstRungNow.co.uk, argues that if people are to have a hope of getting on the ladder in future, schemes like these are the only way. "We've been saying for years that the future of first-time-buyer borrowing is co-financing or co-ownership, so guarantor loans are set to stay."

And they work in reverse too, says Mr Dale. "We see several children acting as guarantors for their parents."

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