Royal Commission reveals dangers of parents going guarantor for children

The dangers of parents going guarantor for children was made obvious at in recent royal commission hearings.

Parents pledging their homes as security for bank loans to their offspring with entrepreneurial aspirations was centre stage.

The commission heard an elderly pensioner, who was legally blind, did not have a clear memory of signing the loan guarantee, and or receiving independent legal advice before a $160,000 Westpac mortgage was taken over her Penrith district home.

It certainly didn't look good, but Westpac did not breach the bank's lending guidelines in accepting the mother's guarantee when her daughter borrowed the money to buy a Poolwerx franchise.

For decades banks have taken the precaution of property as security in case the business fails.

Currently Westpac lends up to $50,000 on an unsecured basis.

For higher amounts, the bank demands security which typically sees the borrower's own family home pledged.

But if they don't have property of their own, parents guarantee the loan using their homes as security.

Around one-third of all small business lending is secured by residential property. 

It is calculated that one in three small businesses fail in their first year of operation, two out of four in the second year, and three out of four by the fifth year.

Little wonder Westpac's credit manual recommends that business bankers use "extreme caution" when it comes to parents guaranteeing the business borrowings of their enterprising children.

In recent times first home buyers have escalated their borrowings from the so-called “Bank of Mum and Dad”, which accounts for more than $20 billion in property loans.

This appears mostly being parents utilising their own cash reserves, plus using longheld equity in their house to help finance their child’s first home.

The trend includes going bank guarantor too.

The Bank of Mum and Dad now ranks as the 10th largest lender in the country, Digital Finance Analytics suggested with the cash injection averaging around $90,000.

Parental guarantees are clearly risky for business lending, but to date we've been fortunate when it comes to first time home purchasing lending.

Sydney's rising property prices and equity, low interest rates and strong employment has meant property foreclosure disasters have been kept at bay.

But they might loom. 

I'd suggest it is ultimately up to children, nor parents, bankers and the royal commission, to determine whether guarantees are unconscionable because they could leave elderly parents homeless. 

It was interesting the Royal Commissioner Kenneth Hayne noted there was likely a time where parental feelings of duty and support and affection and sentiment and the commercial assessment of the transaction could be been seen as matters wholly for the guarantor.

Several years ago Westpac agreed to let the naive aforementioned borrower's mum remain in her home until she dies or decides to sell.

Assumedly Westpac's guarantee was water-tight, but extended given sufficient equity.

This article first appeared in The Daily Telegraph.