Guarantor home loans: How do they work?

Guarantor home loans can help families work together to get a first home buyer into the market sooner.

Saving up for your first home deposit can take time. Finding someone who’ll agree to go guarantor for your home loan could help you take that first step on the property ladder sooner, even if you have a small deposit.

Having a guarantor, and being a guarantor, brings a range of possible risks as well as the potential benefits. So what does it mean to have a parent or other person guarantee your home loan, and is a guarantor home loan the right choice for you?

How does a guarantor home loan work?

A guarantor home loan works much like a normal home loan, but the key difference is that a guarantor provides additional security for the loan – usually by using part of their own home equity.

This can allow you to buy a home with a small deposit, while also avoiding the cost of lenders mortgage insurance (LMI), which normally applies if you have a deposit below 20% of the value of the property you hope to buy.

The guarantor doesn’t have to contribute any cash to your property purchase. Rather, they contribute additional security for your loan, which can help take you up to the equivalent of a 20% deposit or more.

As the homeowner you’ll still be the main person responsible for making regular home loan repayments (including interest and any fees). But if you fail to meet those repayments, your lender may turn to your guarantor to pay off the loan. This is what it means to ‘guarantee’ a home loan.

It’s worth noting that with some guarantor home loans, the guarantor doesn’t have to guarantee all of your loan. Your guarantor may have the option to guarantee a specific portion, for example, just 10% of the loan.

This would mean that once you’ve repaid that portion, the guarantor is free from any further obligations – and from any personal financial risk should you miss repayments further down the track.

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What types of guarantors are there?

Not all lenders offer guarantor home loans, but among those that do, many require your guarantor to be an immediate family member, such as a parent or partner. Other lenders may allow siblings or grandparents to go guarantor.

Lenders generally like to see a strong relationship link between the guarantor and the borrower. If you plan to use, say, an aunt or uncle as your guarantor, then the Home Loan Experts mortgage brokers website says your relatives may be asked to sign a statutory declaration confirming they have a close relationship with you.

The common link is that to be accepted as a guarantor by a lender, your guarantor usually needs to offer equity in a property (such as their own home) as security for all or part of your mortgage.

The person you choose as guarantor will usually also need to have a good credit record themselves. In addition, many lenders like to see that the guarantor is earning an income. The UNO mortgage brokers website says a relative who is retired may not be accepted by a lender to act as a guarantor.

Family guarantee home loans

As the name suggests, family guarantee home loans are designed for a family member to act as guarantor for the loan.

You may see family guarantee home loans marketed under a variety of names, such as family security guarantee or family pledge loans. Broadly speaking, most require a close family member, often mum or dad, to act as guarantor for their adult child’s home loan.

What matters for the lender, is that the family member can provide what the lender regards as an acceptable form of security.

As we’ve noted, this security is often equity in a residential property, though some lenders may accept a cash deposit as part of the loan security. The funds may be held with the lender in a term deposit to earn interest but cannot usually be accessed by the guarantor while the guarantee is still in place.

How much can I borrow with a guarantor home loan?

Some lenders may let you borrow up to 100% of the value of the property you’re buying if you have a guarantor. This really depends on the lender, your financial standing as a potential borrower and the circumstances of your proposed guarantor or guarantors, as well as factors such as the size of your loan.

As with any home loan, your lender will still consider whether you can afford your loan repayments, along with your track record of saving. Some banks may also require you to save a certain amount towards the deposit – say 5% in genuine savings –  even if you have a guarantor.

Before applying for a home loan or asking someone to go guarantor for you, it’s generally worth taking a deep dive into your income and living expenses to ensure you have the capacity to repay the loan and have some wiggle room for any unexpected expenses.

Asking someone to act as a guarantor because you have a low deposit likely means you will be taking out a bigger home loan. This can mean making higher loan repayments compared to borrowers with a larger deposit, and it’s important to be sure you can comfortably manage the loan.

It is also a good idea to confirm with your guarantor the amount they are willing to guarantee in advance of entering any formal agreement. In fact, lenders tend to require or recommend that anyone raising a hand to act as guarantor seeks independent legal advice.

What are the pros and cons of a guarantor home loan?

It’s a good idea for home buyers and guarantors to carefully weigh up the pluses and minuses of a guarantor home loan. Here are some points to consider.

The pros of a guarantor home loan

• A chance to buy a home with a small deposit – having a guarantor could help you secure funding from a lender if you don’t have enough saved for a 20% deposit. This may mean being able to buy your first home sooner.
• Saving on lenders mortgage insurance (LMI) – having a guarantor for your home loan can help you avoid LMI – a cost that could otherwise run into thousands of dollars.
• Guarantors don’t have to contribute cash to the home purchase – the guarantor is not usually required to hand over any cash for the initial purchase of the home.

The downsides of a guarantor home loan

• The loan could end up costing you more – if you use a guarantor to buy with a small deposit, the home loan could end up costing you more in the long run since you’ll be paying interest on a larger portion of the property’s value.
• The guarantor could be asked to repay all or part of the loan – agreeing to be a guarantor is not just a formality. As the federal government’s Moneysmart website warns, it’s the guarantor, who is ultimately liable to pay off the mortgage if the borrower is unable to. Any potential guarantors should carefully consider the decision to go guarantor, as it could put their hard-earned savings or potentially their home at risk.
• The guarantor’s ability to take out a loan can be impacted – Moneysmart adds that agreeing to act as a guarantor may limit the guarantor’s ability to take out a loan themselves.
• The relationship can be impacted – if the guarantor is called on to pay off the loan, the relationship could become strained.

On the plus side, a Reserve Bank of Australia (RBA) study found that even though first home buyers often start out borrowing a high percentage of their home’s value, they have been no more likely to report financial stress or to fall behind with their loan than other, more seasoned home buyers.

What are some other ways my family could help me buy a house?

If a guarantor home loan doesn’t sound like the right option for you but you still need a little help to get onto the property ladder, there are other ways your family could lend a hand.

They could pay some money towards your deposit as an informal loan that you can pay back to them over time, which may allow you to put down a 20% deposit and avoid paying LMI. Your lender may ask whether the money provided by your family was a loan or a gift, and this could factor into its decision to approve or decline your home loan application.

You could move back to the family home to cut down on expenses such as rent and bills, to allow you to put the savings towards a deposit (the average age for leaving the family home has been rising anyway.)

Co-signing a home loan with your family means you would both be legally responsible for the loan repayments but your parents wouldn’t have to put up their house as security.

Keep in mind, though, co-signing a loan could potentially impact your eligibility for any first home owner grants or concessions.

What is the First Home Guarantee?

First home buyers may also consider the First Home Guarantee, which used to be known as the First Home Loan Deposit Scheme.

In the 2022/23 financial year the guarantee allows up to 35,000 eligible first home buyers to buy a home with a deposit as low as 5%. The federal government effectively guarantees up to 15% of the purchase price, which means participants are not required to pay LMI.

But as mentioned earlier in co-signing a home loan, to be eligible for the guarantees scheme the conditions include that you must not have previously owned, or had an interest in, a property in Australia.

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Cover image source: Monkey Business Images/Shutterstock.com.