What is a guarantor home loan?
A guarantor home loan is when someone, normally a parent, provides a ‘guarantee’ for the repayment of a home loan.
This means that they are legally responsible for paying back that portion of the loan in the event that the borrower is unable to make their mortgage repayments.
To guarantee the loan, the guarantor will offer equity, often from their own property, as additional security for the mortgage.
The guarantor can choose to guarantee only part of the loan (such as 20%) instead of covering the full amount. This can enable a home buyer to take out a larger loan without needing to save up for the 20% deposit required by most lenders.
Who can be a guarantor for a home loan?
In most cases, a parent will act as the guarantor for a mortgage. Some lenders will also accept other close family members such as partners and siblings to act as a guarantor.
Each lender has their own criteria, with the following requirements often factored into a guarantor’s eligibility:
- Having equity in an existing property
- Having a good credit score
- Earning a stable income
How much of deposit do I need for a guarantor home loan?
Typically, lenders require the borrower to pay Lenders Mortgage Insurance when they can’t put down a deposit worth at least 20% of the properties value, plus stamp duty. This is because if the borrower cannot repay their mortgage and the value of the property drops, a 20% deposit will likely ensure that the sale price still covers the outstanding loan amount.
However, with a parent or close family member ‘guaranteeing’ the mortgage, the risk to the lender is minimised due to the additional security on the loan repayment.
Because of this, lenders may not even require a deposit to approve a guarantor home loan.
What are the benefits a guarantor home loan?
More than anything, a guarantor will help you feel supported during your application.
Having a guarantor is an avenue that speed-tracks the path to property ownership for many Australians. With house prices increasingly unaffordable for first-home buyers, a guarantor can help you skip many years of saving up for a large deposit.
Additionally, LMI costs can be substantial and ultimately only protect the lender’s risk. A guarantor home loan can save you needing to pay Lenders Mortgage Insurance, regardless of the size of your deposit.
What are the potential risks of a guarantor home loan?
If you enter into financial hardship, lenders will want to work with you until you are back on your feet. Taking action on a defaulted home loan is not profitable and something they usually wish to avoid. Typically, lenders will try to make arrangements with the borrower long before repossession proceedings are necessary.
However, there are potential dangers for the guarantor if borrower is unable reach an agreement over the repayment of their mortgage.
In this event, the lender has the right to force the sale of the borrower’s property to recover the value of the loan. If the sale price doesn’t fully cover the outstanding loan value and sale costs, the responsibility to repay the loan falls on the guarantor.
If the guarantor is then unable to fulfil their guarantee, the lender has the right to take necessary action to recover the remaining loan value. In this scenario, possible solutions for the guarantor include:
- Taking out a personal loan
- Refinancing the outstanding loan into their existing mortgage
- Paying off the debt through superannuation or other assets
In the worst case scenario, a lender can start repossession proceedings on the guarantors home. For lenders, this is seen as a last resort and a lot of things need to go wrong before this outcome is reached.
Acting as a guarantor can also add additional complexity and constraints when it comes to their own mortgage and borrowing capacity.
Regardless, it’s important that both the borrower and guarantor are aware of all the possible consequences if the loan is unable to be repaid.
Before entering into a guarantor home loan, be mindful of the strain or damage to the relationship with your guarantor in the event that something goes wrong.
When can a guarantor be removed from a home loan?
A guarantor will stay on the mortgage until the loan is refinanced or paid off. Although the guarantee applies for the duration of the home loan, the guarantor can apply to have it released before then if enough equity in the loan has been built.
For example, if the guarantor has chosen to only guarantee 20% of the loan, they can apply to be removed once the LVR on the purchase property falls below 80%.
If you’re want to learn more about how a guarantor might help your home loan application, speak to one of our mortgage brokers at Elephant Advisory.
