Insurance, guarantees and risk mitigation in residential lending
Domain 8 - Insurance, guarantees and risk mitigation in residential lending
This domain tests how lenders protect the loan against property, borrower and guarantor risk.
Core rules
- Residential lenders normally require the house to be insured for replacement cost, with the lender's interest noted.
- Lender's mortgage insurance, low-equity premiums or guarantor support may be used for high-LVR lending; each shifts risk but does not remove borrower liability.
- A guarantee must be documented, preferably limited in amount and duration, and the guarantor should receive independent legal advice.
- Cross-collateralisation lets a lender use one property as security for another loan; it increases risk to the guarantor's property.
- Risk mitigation also includes accurate valuations, building reports and conditions such as a code compliance certificate.
Worked example
Parents guarantee 20% of a child's $700,000 loan using their own home. The bank should assess the parents' income and assets, obtain a limited guarantee, and require independent legal advice. If the guarantee is unlimited or cross-collateralised, the parents' home is exposed beyond the intended 20%. The adviser should explain the difference and document the parents' understanding.
Traps
- Treating a guarantee as a substitute for the borrower's ability to repay.
- Assuming lender's mortgage insurance protects the borrower; it usually protects the lender.
- Letting insurance lapse without checking the mortgagee clause.
- Accepting a guarantee without independent advice.
- Ignoring cross-collateralisation in the guarantor's risk.