Having a guarantor, and indeed being a guarantor comes with a range of potential risks as well as the potential benefits. So, what does it mean to have a parent or other person guarantee your home loan, and what does it involve?
What is a guarantor home loan?
A guarantor home loan allows family members or, in some cases, someone else who is close to you, to ‘guarantee’ the loan. This means they will be responsible for paying back the loan if you can’t. A guarantor usually has to offer equity (such as a percentage of their own home) as security for part or all of your mortgage.
Typically, as the homebuyer you’ll still be the main person responsible for making the regular repayments on your mortgage (including any interest and fees), but if you fail to meet those repayments, the person who guaranteed your home loan (referred to as the guarantor) may become liable to cover them.
Like a normal home loan, for a guarantor home loan you would borrow an amount from a bank and repay it, but the guarantor’s equity essentially acts as additional collateral should something go wrong, which means the bank could take possession of it if your guarantor also can’t meet the repayments.
There may also be the option for your guarantor to only guarantee a portion of the loan, which would mean once you had repaid that portion, they would be free from any risk to their property should you miss any repayments further down the track.
Who can act as my guarantor?
Lenders generally require your guarantor to be an immediate family member, such as a parent or partner, but some may also allow others such as a sibling or grandparent, or in some instances a close friend, to go guarantor. Different banks often have different requirements of what makes someone eligible to be your guarantor, some of which can include having:
- A good credit score
- Equity in a property to be used as security
- A stable income
How much can I borrow with a guarantor?
Some lenders may let you borrow up to or even above 100% of the value of the property you’re buying if you have a guarantor, but it 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 like 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 even though 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.
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.
What are some benefits of a guarantor home loan?
One of the main benefits of having a guarantor on your home loan is that it may help you avoid paying Lenders Mortgage Insurance (LMI). This is a fee paid by the borrower to the lender to protect the lender against financial loss should the borrower be unable to meet their mortgage repayments. It can be paid upfront as a one-off or added to your loan repayments, depending on the lender. Lenders typically require borrowers to pay LMI on loans where the borrower has a deposit of less than 20% of the property’s value.
In the case of having someone go guarantor for you, however, the risk to the lender is already minimised by having the guarantor’s property as added security. A guarantor could also help you secure funding from a bank if you don’t have enough saved for a 20% deposit, and can help reassure the bank that mortgage repayments will be covered even if something unexpected occurs and you can’t pay.
While there are some benefits to guarantor home loans, there are also a number of potential risks to be aware of.
What are some potential cons of a guarantor home loan?
The main risks and drawbacks associated with a guarantor home loan are for the guarantor, who is ultimately liable to cover mortgage repayments and fees 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 and delay retirement plans.
ASIC warns on its Moneysmart website that when requesting credit for themselves, your guarantor will need to tell lenders about any loans they’re guaranteeing, which could prevent them from getting a new loan even if you’re still on track with your home loan repayments.
First home buyers who have received help from family or friends to pay for their home loan are more likely to experience cash flow problems, such as difficulty paying utility bills or meeting mortgage repayments, according to the RBA. The central bank found in recent research that more than 30% of people who needed help from their parents to pay for a deposit were experiencing financial stress.
Some other potential cons of a guarantor home loan include:
- If you use a guarantor to avoid paying LMI rather than saving up a 20% 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.
- Your relationship with your guarantor could be strained by such a serious financial commitment.
- If you don’t meet your repayments, you and your guarantor’s credit report could be negatively impacted and in some cases, your guarantor may have to sell their home to repay your home loan.
Other ways your family could help you buy a house
If a guarantor home loan just doesn’t sound like the right option for you but you still need a little help to get onto the property ladder, your family could help by:
- Paying 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. Note that your lender may ask whether the money provided by family was a loan or a gift, and this could factor into its decision to approve or decline your home loan application.
- Letting you move back home to cut down on expenses such as rent and bills, allowing you to put the savings towards a deposit.
- Co-signing a home loan with you, meaning you would both be legally responsible for the loan repayments but your parents wouldn’t have to put up their house as security. Depending on your loan contract and whether your parents are listed as co-owners of the home you buy, this could also be seen as an investment property of sorts, that your parents could potentially earn a profit from. Keep in mind, co-signing a lease could potentially impact your eligibility for any first home owner grants or concessions.
Other guarantor options: What is the First Home Loan Deposit Scheme?
The First Home Loan Deposit Scheme (FHLDS) allows up to 10,000 eligible Australian first home buyers per year to buy a house with a deposit as low as 5%, with the Federal Government effectively guaranteeing up to 15% of the purchase price, although they will still need to pay interest on the total amount they borrow, as with a guarantor home loan. This means participants will not be required to pay LMI.
Cover image source: courtneyk (iStock)