What is a Guarantor Home Loan?
With pressure growing for young Australians to become first home buyers, a guarantor home loan can help them start their homeownership journey. In guarantor home loans, the lender uses the borrower’s property as the main security for the debt (as in conventional home loans) while also using the guarantor’s property for the mortgage.
Definition of Guarantor
A guarantor, simply put, is someone who guarantees a loan for a borrower. They allow their home equity to be used as additional security against the loan, making the borrower a less risky prospect for the lenders. The guarantor has the legal responsibility to pay the loan if the borrower fails to pay them back. A guarantor doesn’t have to provide security for the whole loan amount or the entire loan period. They can choose the amount of home loan they want to guarantee, and that is the amount they’ll be liable for in the event that the borrower defaults. Likewise, once the borrower reaches a loan-to-value ratio (LVR) of 80 per cent, they can let go of their guarantor.
The lender might ask for a guarantee if they don’t see you fit for a loan on your own. It is becoming a popular way to qualify for a loan and avoid paying the lender’s mortgage insurance (LMI) for first home buyers. But as common as it is getting, this strategy requires a great deal of commitment and may be somewhat risky for the guarantor.
Who can be a Guarantor?
Practically anyone can become your guarantor, provided that they:
- have sufficient equity to offer in their home
- have a steady income stream
- are 18 years of age or over
- are a citizen or permanent resident of Australia
Sometimes, they are required to be a homeowner themselves and maintain a good credit rating.
Since heavy financial risk is involved, most lenders prefer that the borrower’s immediate family members, such as a parent, sibling, or grandparent, fulfil the role of the guarantor. Occasionally, lenders will allow an extended family or close friends to act as a guarantor, although this can depend on the type of mortgage and the amount you are borrowing.
Benefits of a Guarantor Home Loan
While the guarantor does not get financial gains for going guarantor on a home loan, it benefits the person you support.
Enter the property market sooner
Having a guarantor on your home loan could help you buy your property sooner. A sizeable home deposit is very beneficial for first home buyers, but that could take years to save. However, if you can fulfill the necessary loan repayments, getting a guarantor on your loan can help you secure it faster than only relying on saving for a large deposit. You can get the mortgage without the required 20% deposit.
Avoid paying LMI
The lenders require you to pay lenders mortgage insurance (LMI) if you have a loan to value ratio (LVR) higher than 80% because that categorizes you as a high-risk borrower. A guarantor can help you avoid this payment as their home will be used as extra security against the loan, making you a low-risk candidate for the lenders.
In a guarantor home loan, your borrowing capacity is improved so that you can borrow a little bit more than 100 per cent of a property’s purchase price, which can cover charges such as stamp duty and legal fees.
Look around for better interest rates
With a high LVR, loans are generally offered at a high-interest rate. By having a guarantor on a home loan, you can lower your LVR and access home loans with more competitive rates.
Risks of a Guarantor Home Loan
While going guarantor on a home loan for your loved ones is a wonderful way to support their dream of becoming a homeowner, it comes with serious risks for the guarantor. So the majority of lenders restrict this type of loan to members of the immediate family - usually a financially strong parent who is also a homeowner.
The most prominent risk of all is the liability. Signing that guarantee means that the guarantor will be liable to clear the debt, and the lender can take over their assets if the borrower defaults on the repayments or fails to repay the home loan in full for any reason.
Being a guarantor also shows on your credit history, which can affect your chances of qualifying for other loans in the future or getting credit cards. If you are considering going guarantor on a home loan, you should consult a financial professional in advance.
Alternatives to Going Guarantor
Going guarantor on a home loan isn’t the only way to help your loved ones to start out in the property market. There are other options to help them without putting yourself at risk.
Offer them the money as a gift
Rather than increasing your liability by being a guarantor, consider offering them the money as a gift or an early inheritance which could then be used for a deposit. Or you can purchase the property on their behalf or as a partner with them.
Help them save
You can also let them live with you for a reduced rent (or rent-free) to help them save up for their down payment.
Try applying for First Home Owner Grant or other such schemes which are designed to encourage and assist first home buyers.
While becoming a guarantor may bring a feeling of satisfaction, we strongly suggest you seek independent financial and legal advice before committing. There are risks associated with guarantor home loans, more so for the guarantor, so you should not jump into the situation without full knowledge of it.
Talk to your legal advisor or call Capkon for more information on Guarantor home loans.