Nick Bruining Q+A: The hidden (and costly) danger of being a home loan guarantor for your kids

Question

I have recently been approached by one of my children to go guarantor for a $700,000 loan to allow her and her partner to buy their first home, which is on the market for $800,000.

I own my home and have about $520,000 in super.

While I would like to help them, I am a primary school teacher approaching retirement and am slightly concerned how this might affect any age pension benefits.

Can you provide any advice?

Answer

With house prices continuing to rise, the “Bank of Mum and Dad” is now becoming an integral part of financing a first home for many young people.

While tough, you are right trying to understand the consequences of becoming a guarantor of a significant loan such as this.

A lender requires a guarantor when there are concerns about the capacity of the borrowers to service the loan and, also, what might happen in the event that the borrowers default. After making extensive attempts to resolve any issue with the borrower, a guarantee means the lender can come to you, demanding repayment of the outstanding loan balance.

This can, and has, resulted in guarantors having to sell their own home to cover the debts of their children. You need to consider a worse-case scenario which, while hopefully unlikely, could occur.

As it stands, the equity of the borrowers indicates their “skin-in-the-game” will be no more than 12.5 per cent. If the house were to fall in value by more than this amount and if the house were sold — realising a net sale amount less than the outstanding loan balance — your guarantee may kick in and you would have to pay the difference.

A forced sale could result from unemployment, illness, death, or a relationship breakdown.

Significantly, if you pay the money to the lender, this will be regarded by Centrelink as a gift and could affect your own position.

Based on your finances, it seems likely you will be an asset-tested pensioner. The existence of the guarantee itself will not affect your pension unless it is activated by the lender.

While you wouldn’t lose any pension by paying out the debt and, in fact, may see a slight increase initially, you will have lost the use of that money and your pension will reflect that “gift” for five years. After that, the pension would probably increase, but only up to the maximum fortnightly amount applicable at that time.

Question

I am an engineer in my 30s with about $300,000 in superannuation.

Having successfully invested in shares over the past five years, I am keen to take control by investing in the market through my super.

While my fund has a share option, I want to deal with specific stocks. I am not keen on setting up a self-managed super fund because the costs just don’t add up.

What other options are there?

Answer

In addition to an SMSF, there are a number of alternatives to consider. But as you have identified, costs are a significant issue to be addressed.

Superannuation “platforms” will allow you to trade in individual shares, other listed investments and wholesale versions of many managed share funds. Netwealth, Hub24, CFS Edge, BT Panorama and Macquarie Wrap are among the largest.

In all cases, these wrap funds, while often cheap to operate, will require you to engage a financial adviser to establish and instigate transactions within the fund. That means adviser costs — both initial and ongoing — can make these expensive alternatives unless you negotiate minimal adviser costs and there are substantial sums to be invested.

In my view, the viability of these arrangements only stacks up when funds exceed about $800,000.

What’s not broadly known is that many popular low-cost super funds allow you to directly trade in shares and exchange-traded funds. Australian Super, ING Super, Hostplus, Superhero and others all permit direct share investments — typically limited, however, to the ASX 300 and selected ETFs.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association.