A guarantor home loan is often referred to as a home loan for when a buyer does not have a deposit, or has only a small deposit to contribute to their home purchase.
Most borrowers are keen to have a deposit of up to 20%, so that their loan to value ratio is 80% or less. This is because many lending institutions require some level of Lenders Mortgage Insurance (LMI) for a home loan where you are seeking to borrow more than 80% of the value.
Guarantors can provide the loan security you need to avoid paying LMI and increase your eligibility for a home loan. Guarantors are usually parents or close family members who are willing to use equity (money) in their own home as a 'guarantee'.
Lenders mortgage insurance (LMI)
Guarantors can help you avoid paying expensive lenders mortgage insurance which is a requirement for home loan deposits less than 20% of the purchase price of the property. If you avoid paying LMI and only need a small deposit of 5% or 10% you could buy your own property sooner.
LMI protects the lender (credit union or bank) if the borrower defaults on loan repayments and the lender is required to sell the property. If the sale price is lower than the home loan amount and the repayments made, LMI protects the lender against the short-fall. The cost of the LMI is passed onto the borrower.
How do guarantor home loans work?
A guarantor home loan works by adding additional security to the borrower's home loan. If a close family member agrees to be a guarantor, they use their own home equity as insurance to the lender if the buyers house deposit is less than 20%. Home buyers make the loan repayments.
Lending specialists will assess if the borrower can comfortably manage the loan repayments, they use the guarantor as security on the loan. Lending Specialists will also assess as to whether the guarantor could afford to make the payments, in the event that the borrower defaults on loan repayments.
At Northern Inland, if the repayments are not affordable, without hardship, by either the borrower or guarantor, the loan application does not proceed.
The main difference between a regular home loan and a guarantor home loan is what happens if the borrower defaults on their repayments.
With a regular home loan the responsibility to pay the loan back falls solely on the borrower, with a guarantor home loan the responsibility falls on the guarantor in the event of default. Lenders may sell the property to cover what is owed, if the sale price covers what is owed, the debt is settled under a regular mortgage and a guarantor mortgage.
Providing a guarantee is a significant issue and anyone thinking of providing a guarantee should first seek personal advice from the solicitor, accountant and financial planner.
How much equity is required for a guarantor home loan?
The guarantor must have enough equity in their property to cover up to 20% of the property price. For example, if the loan amount is $600,000 there must be $120,000 (20%) of equity.
This can be reduced if the borrower pays a larger deposit, 15% instead of 5% for example.
The equity in the guarantor's property must be enough to cover their own property with their lender as well as the security guarantee they are committing to as guarantor.
What are the risks for guarantors?
There are significant risks for guarantor home loans and going guarantor is a significant financial decision.
The benefits are also large, if you have sufficient equity in your property you could save a family member thousands of dollars and help them purchase their new home.
It is important to weigh up the benefits and the risks associated with a guarantor home loan to make sure it is suitable for both the guarantor and home buyer. Providing a guarantee is a significant issue and anyone thinking of providing a guarantee should first seek personal advice from the solicitor, accountant and financial planner.
Defaulting on loan repayments
If the borrower defaults on their mortgage repayments the guarantor is responsible for making payments.
If the security guarantee is limited, the guarantor is responsible for the agreed amount only. For example, if the loan amount is for $600,000 and the guarantee is $100,000 then that is the limit of the guarantors responsibility. If the property is sold for $600,000 then the guarantor does not have to pay anything, however, if the property value drops and is sold for $550,000 the guarantor is required to pay the $50,000 shortfall. If the property sells for less than $500,000 the guarantor is only required to cover the $100,000 limited security guarantee.
Most lenders will try and avoid selling the property unless necessary, and will work with the property owner and guarantor. Alternatives might include the guarantor taking out a second mortgage to cover the second property.
There are also enforcement costs.
Advantages of a guarantor loan
Enter the property market sooner
Having a low deposit can be one of the biggest barriers to buying a home. You may have a stable job which will cover repayments and meet most aspects of the eligibility criteria but only have a small deposit. Entering the property market sooner can have many financial benefits, you move into your own home sooner and with a guarantor loan you do not have to pay LMI.
A guarantor loan can increase your eligibility to take out a larger loan which may help you get the property that suits you more. Allowing you to buy a property which will suit you and your family for longer, requiring less property purchases and moves in the future.
Lower interest rates
With the added security of a guarantor a lender may offer you a more favourable interest rate which could save you thousands of dollars.
Lower deposit requirements
Many lenders require borrowers to make a substantial down payment when buying a home, typically around 20% of the property's purchase price. However, with a guarantor loan, you may be able to purchase a home with a smaller deposit, or even none at all in some cases. This can make home ownership more accessible for those with limited savings.
Alternatives to a guarantor loan
Pay lenders mortgage insurance
An obvious alternative could be paying LMI on a home deposit of less than 20%. Although LMI can be costly it could allow you to enter the market and stop renting which could be financially beneficial in the long run.
Compromise on property
Consider Compromising on the property or location can reduce the amount you need to borrow and the deposit required. This can help you enter the market sooner and climb the property ladder in the future when your borrowing power might be greater.
Does a guarantor home loan suit you?
It depends on your personal circumstances and what suits you and the guarantor. Buying a house has additional fees such as stamp duty, conveyancer fees, building and pest inspections to consider too.
Buy within your means, having a small deposit means that a larger percentage of the loan amount will be subject to interest. This can significantly increase the total amount paid over the loan term. If you buy a more affordable house you could have more disposable income for other things and you can always make extra repayments on your loan to pay it off sooner.
The risks to the guarantor must not be taken lightly. To make a guarantor home loan work, the borrower must make the repayments without issue, and meet all the terms and conditions of the loan contract, such as ensuring the property is always insured, and rates are paid in full.
If they default, it can place significant strain on relationships, financial stability and even threaten the guarantor's property which could be the family home.
The advantages of a guarantor loan are significant, avoid paying lenders mortgage insurance and increase your property eligibility with a low deposit. You need to weigh up these great benefits against the risks before making a decision. Seek advice from a professional financial planner to see if a guarantor loan suits your needs.
This article is general in nature and does not constitute personal advice. Consider your circumstances and read terms and conditions before making a decision on whether a product suits your needs.