No one has your back quite like family. This is especially true when you need financial help to achieve your goals, whether it’s owning your first home, throwing a wedding or buying that dream car.
One way to access the help you need is through a guarantor loan: an arrangement where a family member helps you qualify for a loan by providing the lender with a guarantee. Here is the run-down on how guarantor loans work, as well as what you need to consider before applying for one.
Guarantor and co-borrower: what’s the difference?
A guarantor is someone who signs a guarantee on behalf of a borrower when they apply for a loan. By doing so, they become legally responsible for paying back the lender if the borrower defaults on the loan. This is different from a co-borrower, who signs a loan with someone and is jointly responsible for repayments. A guarantee is a separate but linked part of the loan – an extra form of security that makes the borrower a less risky prospect for the bank.
Due to the financial risk involved, the role of guarantor is usually limited to the borrower’s immediate family members. Some lenders allow an extended family or close friends to be a guarantor, although this can depend on the type of loan and how much you are borrowing.
Going guarantor on a home loan
With pressure mounting for those trying to enter the property market, it’s no surprise a home loan is one of the more common types of guarantor arrangements in Australia.
Guarantor home loans allow the guarantor to use equity in their own property as security for the loan. This means that while the borrower’s property is the main security for the home loan (like a traditional home loan), the lender will also take a mortgage over the guarantor’s property.
A guarantor doesn’t have to provide security for the entire loan amount; they can choose how much of the home loan they want to guarantee. If you decide to only guarantee a portion of the loan, if the borrower defaults on payments, you are only liable for that portion.
A guarantor can also be released from the loan once their borrower builds up enough equity in their property – in most cases, when the borrower reaches a loan-to-value ratio (LVR) of 80 per cent of the property’s value.
What are the benefits of having a guarantor on your home loan?
There are several benefits worth mentioning:
- Avoid paying lender’s mortgage insurance (LMI). Home loans with an LVR of over 80 per cent are considered high risk by lenders. This means the borrower is required to pay for LMI: a type of insurance that protects the lender from a loss if you default on the loan. A guarantor can help you avoid this payment by lowering your LVR to below 80 per cent.
- Increase the amount you can borrow. If you have a guarantor, some lenders will let you borrow slightly more than 100 per cent of a property’s purchase price, which can help with costs like stamp duty and legal fees.
- Shop around for a better interest rate. Generally, loans with a high LVR come with a high interest rate. By using a guarantor, you can lower your LVR and gain access to home loans with more competitive rates.
- Get into your property sooner. Having a guarantor means you can get a home loan faster than if you solely relied on saving for a sizeable deposit.
What are the risks of a guarantor home loan?
Agreeing to be a guarantor for someone comes with considerable financial risk, which is why most lenders restrict this kind of borrowing to members of the immediate family – usually a financially secure parent who owns their own home.
The biggest financial risk is liability. If a borrower can’t make repayments on their home loan, the guarantor is responsible for clearing the debt and their asset can be seized by the lender.
Being a guarantor also appears on a person’s credit file, which may affect their ability to get credit cards and other loans in the future. If you are considering being a guarantor for someone’s home loan, it is worth speaking to a financial adviser before you do.
Going guarantor on personal loans
Another way borrowers use a guarantor to secure funds they need is through a personal loan. This can be a suitable option if you are unable to meet the criteria for a loan on your own, or if you want to get a better interest rate by decreasing your risk to a lender.
There are generally two types of guarantor personal loans:
- A secured guarantor personal loan is when a guarantor uses their asset – for example, their property, car or boat – as security for the personal loan. If the borrower defaults on the loan, the lender seizes the asset to pay back the money.
- An unsecured guarantor person loan doesn’t require an asset, so tends to attract a higher interest rate as the lender is taking on a greater amount of risk.
Each lender has its own rules regarding who can act as a guarantor of a personal loan. Some accept extended family members and even close friends; others keep it restricted to members of the immediate family.
It’s worth taking the time to research which guarantor personal loan suits your needs – use the RateCity website to compare different products and interest rates on the market.
Going guarantor on a car loan
Buying a new car is another situation where a borrower might need the help of a guarantor, especially if they have a chequered credit history, or your dream car comes with a hefty price tag.
Being a guarantor for a car loan – for example, if your child has started a job and needs a car for transportation – can be a good way to financially help out a family member without having to actually outlay any money. For borrowers, it can help you avoid falling prey to car lenders with questionable practices.
What to consider before getting a guarantor loan
Taking out a guarantor loan from a lender is a big commitment – both for the borrower and the guarantor who is taking on considerable financial risk.
Before signing on the dotted line with a lender, think through the decision carefully and make sure you have all the information you need.
Here are some questions to help you cover all your bases.
- What are the terms of the loan? Make sure you know exactly what you are getting yourself into by clarifying what type of loan you are applying for; what is being put up in security; whether the guarantee is for the total or a fixed amount; exactly how much the guarantor will owe if the borrower defaults; how long the borrower has to repay the loan.
- What financial situation is the borrower and guarantor in? It is important for both parties to assess whether the guarantor can take on the financial risk, and if the borrower has the financial means to pay back the loan.
- Is your relationship secure? In some cases, going guarantor can damage your relationship with your parent, child, sibling or close friend.
- Does the guarantor understand the risks involved? Remember – when the loan can’t be paid back, a lender doesn’t have to take things further against a borrower before holding the guarantor legally responsible for the debt.
- Have you sought advice? Before agreeing to go guarantor, it is recommended that you seek both financial and legal advice from a qualified lawyer and financial adviser.