Guarantor home loan - how do they work?
A guarantor could enable you to purchase a property sooner and potentially save thousands of dollars
By using the equity they've built up in an existing property, a guarantor may provide security that enables you to buy a home or invest in residential property (known as a security guarantee). They may also offer a security and income guarantee whereby their income can help to satisfy the serviceability of the loan.
How does a guarantor loan work?
A guarantor loan works when someone with security, such as equity in their own home, agrees for a purchaser to use it as security against a new loan for their property purchase. One of the most common reasons property buyers use guarantors is to avoid paying Lenders Mortgage Insurance (LMI). This is a form of insurance that protects lenders from borrowers defaulting on loan repayments and is payable if you only have a small deposit, usually below 20% of the total property sale price.
If you don’t have at least a 20% deposit, you will often have to pay LMI, which can be as much as $10,000. However, if you have a guarantor who agrees for their own security (such as their property) to be used for your purchase, you may be able to borrow a larger percentage of the property’s value and not pay LMI.
A security and income guarantee not only uses the guarantor’s equity as security, but also their income to be calculated toward determining the serviceability of the home loan, meaning whether they could assist you to meet repayments should you experience troubles.
Guarantor loans could help you to get a foothold in the property market sooner, rather than saving a larger deposit.
It is important to keep in mind that the guarantor’s equity is used as collateral should there be any issues with the repayment of your loan. This means that if anything goes wrong, the lender could take possession of it. There may be an option for a guarantor to only guarantee some of the loan, which means once a certain amount is repaid, they may be removed from the risk should you later default.
Who can use a guarantor?
The most common need for a guarantor is if you are a first home buyer who has a steady income and can service a home loan without assistance, but you do not have the necessary deposit.
Depending on the lender, you may still be required to have at least 5% of the property’s value in genuine savings (held in an account for at least three months) to demonstrate your ability to save. But the amount required for your deposit can, in some cases, be less than this.
Who can be a guarantor?
Guarantors are typically parents wanting to help their children get a foothold in the property market. As well as a parent, a guarantor can also be a parent-in-law or a step parent and grandparents, siblings, close friends, spouses and de facto partners will also be considered by many lenders.
And while lenders have different eligibility criteria, the following usually apply to all potential guarantors:
- Age – they must be over 18 and usually under 65.
- Residency – they must be an Australian citizen or permanent resident.
- Finances – they must have suitable equity in their property and a stable income.
- Credit – they must have a good personal credit rating.
What are the potential benefits of using a guarantor?
One of the key potential benefits of using a guarantor is that it could help you avoid paying LMI. And because it could enable you to take out a loan without saving a 20% deposit it means you could potentially get your foot on the property ladder sooner, which could be particularly useful in times where house prices are rising quickly.
What are the drawbacks of using a guarantor?
The main drawback of using a guarantor is that they become liable should you not be able to make repayments on the loan. Because of this, it is recommended for potential guarantors to seek legal advice before agreeing to the loan as their security could be at risk of repossession or they may need to pay on your behalf if anything should happen and you fail to make repayments.
It is also important to note that guarantors will need to tell lenders about any loans they are guaranteeing, and this could impact their future borrowing potential. If you do not meet your repayments, both your and your guarantor’s credit score will be impacted.
Hypothetical case study of a security guarantee
Anna wants to purchase a property. She doesn’t have enough savings to pay a 20% deposit but can afford the loan amount she needs so her mum, Donna, has offered to provide a guarantee over her unencumbered property. After three years Anna is made redundant, can’t afford her repayments and defaults on her loan. Anna ultimately sells her property at a lower price than she purchased it so it doesn’t cover the full amount she owes the lender.
She’s unable to pay the amount owing so Donna is responsible for paying the remaining balance. If she can’t make the repayment, the lender may seek to sell her property as this was guaranteeing the loan.
When can I remove the guarantee?
There may be an option for the guaranteed amount to be a small percentage of the entire amount of the loan, which means the guarantee could end once that portion of the loan has been paid off.
The borrower and guarantor may apply to the lender to remove the guarantee when the loan amount has been reduced to 80% or less of the property value. This may be achievable in two to five years, particularly if the property has increased in value during that period.
Other ways family could help
If guaranteeing a loan represents too high a risk, there are alternative ways family or close friends may be able to help. For example, they may offer money as a gift or loan to go toward the deposit. Keep in mind that lenders will likely ask whether the money is intended to be paid back and this could impact whether the loan is approved.
You may consider whether moving home for a period of time is an option to save more money for a deposit. There could also be an option for a co-signed loan where both signees are responsible for the loan without needing to put equity towards the security.
A mortgage broker will be able to give you the proper guidance on how guarantor loans work. If you're considering a guarantor loan, a mortgage broker can let you know which lenders are willing to work with guarantors and will be able to negotiate between several lenders to help you find the most competitive product.