Housing affordability is a huge issue in Australia. With mortgage repayments 41 percent higher than in 1984, many first home buyers are finding saving the 20 percent deposit for a home loan is one hurdle that they can’t get over on their own.
If a lender has doubts about whether a borrower can pay off the loan, they may require a financial guarantee, usually from the borrower’s parents. This is known as a “guarantor” loan – and there are risks involved.
How does a guarantor loan work?
Simply put, a guarantor (for example, a parent) allows the equity in their own property to be used as additional security for the borrower’s (for example their child’s) loan. Signing a guarantee for a family member essentially binds you to a promise to pay the entire loan back if the borrower cannot – along with any additional fees, charges and interest.
This is a great thing to do to help your child get a toehold into the property market, assuming all goes well with the repayments. But don’t go guarantor on a loan, be it for your child or for anyone else, without giving it very serious thought and getting some independent professional advice. The reason is, if anything goes pear shaped along the way during the life of the loan, there are legal implications and obligations that could cause you major trouble.
What are the risks of being a guarantor?
A loan secured in this way this can have severe financial repercussions for a guarantor, especially if you’ve guaranteed the loan against your home. For example, if the borrower defaults on the loan, the debt becomes your responsibility, and it could mean you may have to sell your own home to service or clear it.
There are no direct financial rewards for going guarantor, only risk. You do not have any rights to own the property bought with the loan, nor will you receive a better credit rating when the borrower pays off the loan. In addition, your ability to borrow against your own assets may also be restricted if you are a guarantor. With such high stakes involved, a guarantor needs to be totally confident that the borrower can pay the loan back and for this reason, it is important not to be pressured into going guarantor if you have any doubts.
Risk reduction and LMI avoidance
A borrower who requires a guarantor is likely to be someone who would be required to pay Lender’s Mortgage Insurance (LMI) if they didn’t have someone to guarantee their loan. Lender’s mortgage insurance (LMI) is a security cost which is required if you want to borrow more than 80% of a standard loan, meaning if you don’t have a 20% deposit saved, you will be stung with insurance, which could end up costing you thousands.
You can use RateCity’s mortgage repayment calculator to estimate LMI costs based on the borrowing circumstances.
Lender’s mortgage insurance estimate for a no-deposit home loan. Estimate your own LMI with the RateCity Home Loan Calculator
You can help your child avoid LMI while reducing the risk involved with guaranteeing the child home loan. To lessen the risk, it is not always necessary for parents to commit themselves to the entire loan. It is possible to go co-guarantor with your child or to just guarantee a portion of the loan. One option is to limit the guaranteed amount to 20 percent of the purchase price. This will cover the loan’s deposit, helping your child avoid paying lender’s mortgage insurance.
Which home loans offer guarantor option?
Not every home loan in the market offers a guarantor option. Since a borrower that requires a guarantor is considered to be riskier compared to a borrower that does not, these home loan types may have higher costs.
Popular home loans featuring a Guarantor option:
If you are after a home loan with a guarantor option, simply going after the lowest rate you can find is not necessarily the right tactic. At RateCity, every loan has a summary. When a loan supports a guarantor or similar service, it will be stated in the summary: