At a glance
A guarantor home loan allows borrowers to secure a loan with the help of a guarantor, typically a family member, who provides additional security by using their property to cover part of the loan, often helping borrowers avoid Lenders Mortgage Insurance (LMI) and enter the property market sooner.
Guarantors face risks, including potential liability for the guaranteed portion of the loan if the borrower defaults, which could impact their own financial situation, making it essential for both parties to fully understand the obligations and seek legal and financial advice.
Alternatives to guarantor home loans include high loan-to-value ratio (LVR) loans, government schemes, or saving for a larger deposit, and borrowers should carefully weigh their options to determine the best path forward.
Home loans are a critical financial tool for many Australians looking to purchase property. While the traditional route of securing a home loan often requires a substantial deposit and meeting the lender’s credit criteria, a guarantor home loan offers an alternative pathway for borrowers, particularly those with smaller deposits. This type of loan can make home ownership more accessible, especially for first-time buyers who may struggle to save for a large deposit. It allows people to buy a home with the help of a guarantor, usually a family member.
Guarantor home loans have become increasingly popular in Australia due to rising property prices and the difficulty many Australians face in saving for a deposit. In this article, we will explore what a guarantor home loan is, how it works, the benefits and risks involved, and key considerations before entering into such an arrangement. Understanding the ins and outs of this type of loan is crucial for both borrowers and potential guarantors to make informed decisions.
What is a Guarantor Home Loan?
A guarantor home loan is a type of mortgage where a third party, usually a family member, agrees to provide additional security to the lender by guaranteeing a portion of the loan. This guarantee is typically in the form of the equity in the guarantor's own property. The primary difference between a guarantor home loan and a standard home loan is that the guarantor’s property acts as security for part of the loan, which can reduce the lender’s risk and potentially help the borrower secure the loan with a smaller deposit.
Borrowers may consider a guarantor home loan for several reasons, including the ability to borrow a larger amount or to avoid Lenders Mortgage Insurance (LMI), which is usually required when the borrower has less than a 20% deposit. By having a guarantor, the borrower can enter the property market sooner, even if they haven't saved a large deposit (or even no deposit). It is a popular option for first-time home buyers who may struggle to meet traditional deposit requirements.
How a Guarantor Home Loan Works
In a guarantor home loan arrangement, the guarantor provides security by offering part of the equity in their property as a guarantee for the borrower’s loan. This doesn't mean the guarantor makes payments on the loan, but if the borrower defaults, the lender can claim the guaranteed amount from the guarantor’s property. The guarantee usually covers a portion of the loan, such as the deposit, rather than the entire loan amount, limiting the guarantor’s risk to a specific amount.
The relationship in a guarantor home loan involves three key parties: the borrower, the lender, and the guarantor. The borrower takes out the loan, the lender provides the funds, and the guarantor agrees to back the loan. This arrangement lowers the lender's risk, allowing them to offer the borrower better terms, such as borrowing up to 100% of the property value without needing a large deposit. The guarantor’s property remains theirs, but a portion of its value is at risk if the borrower defaults.
Who Can Be a Guarantor?
Generally, the guarantor in a home loan is a close family member, such as a parent or, in some cases, a sibling. Lenders prefer guarantors who have a stable financial history and sufficient equity in their property to cover the guarantee. Guarantors need to demonstrate that they are financially secure and capable of meeting the guarantee obligation if necessary. The guarantor's financial stability is a key factor that lenders consider when approving this type of loan arrangement.
Becoming a guarantor carries significant responsibilities and risks. The guarantor is effectively liable for the portion of the loan they guarantee, meaning if the borrower defaults, the lender can require the guarantor to cover that amount. Guarantors need to consider their own financial situation and be aware of the impact this commitment could have on their ability to borrow or refinance in the future. It’s crucial that both parties fully understand the risks before entering into this type of agreement.
Benefits of a Guarantor Home Loan
For the borrower, the benefits of a guarantor home loan are significant. One of the main advantages is the ability to borrow up to 100% of the property’s value, which means they may not need to save for a deposit. This can be especially beneficial for first-time buyers looking to enter the property market sooner. Another key benefit is the opportunity to avoid Lenders Mortgage Insurance (LMI), which can be costly if the borrower has a deposit of less than 20%.
For the guarantor, the primary benefit is helping a family member secure their home loan, allowing them to achieve home ownership sooner. Additionally, in most cases, the guarantor is only guaranteeing a portion of the loan, not the entire amount. Once the borrower has paid down enough of the loan, the guarantor can be released from their obligations, provided the borrower has sufficient equity in the property. This limited guarantee reduces the financial risk for the guarantor.
Risks Involved in a Guarantor Home Loan
While guarantor home loans offer many benefits, they also come with risks. For the borrower, defaulting on the loan can place their guarantor’s financial stability at risk, as the guarantor is responsible for covering the guaranteed portion of the loan. This can create significant stress and strain relationships if the borrower is unable to meet their repayments. Additionally, borrowers who overextend themselves financially may struggle to manage their repayments, putting both their own and the guarantor’s assets at risk.
For the guarantor, the primary risk is the potential loss of the guaranteed amount. If the borrower defaults on the loan, the lender can require the guarantor to repay the guaranteed portion. This could lead to the guarantor being forced to sell their property or use their own savings to meet the repayment obligations. Furthermore, acting as a guarantor can impact the guarantor’s ability to borrow money or refinance their own mortgage in the future. Guarantors need to fully understand the risks and seek legal and financial advice before committing to this arrangement.
How to Remove a Guarantor from a Home Loan
Guarantors can be released from a home loan once the borrower has built up enough equity in the property. This typically occurs when the borrower has paid down the loan to a point where the loan-to-value ratio (LVR) is below 80%, meaning the borrower now has enough equity to meet the lender’s criteria without a guarantor. Borrowers can also refinance the loan to release the guarantor from their obligations.
The process of removing a guarantor involves contacting the lender and demonstrating that the borrower no longer requires the guarantor’s support. This may involve a property valuation and a review of the borrower’s financial situation. It’s important for both the borrower and guarantor to regularly review the loan and aim to release the guarantor as soon as it is financially feasible.
Alternatives to a Guarantor Home Loan
While guarantor home loans are a popular option, there are alternatives for those who may not wish to involve a guarantor. One alternative is to opt for a high loan-to-value ratio (LVR) loan, where the borrower takes out a loan with a smaller deposit but pays LMI to protect the lender. This option may be suitable for borrowers who do not have access to a guarantor but still want to enter the property market with a smaller deposit.
Other alternatives include taking advantage of first home buyer schemes and grants, which may reduce the deposit required or offer concessions on stamp duty. Additionally, saving for a larger deposit and waiting to buy may be a prudent option for those who are not in a rush to enter the property market. These alternatives should be considered alongside a guarantor home loan to determine the best option for the borrower’s circumstances.
Key Considerations Before Taking a Guarantor Home Loan
Before entering into a guarantor home loan arrangement, it is essential to assess both the borrower’s and guarantor’s financial situations. Borrowers should be confident that they can meet their repayment obligations, while guarantors need to consider the potential impact on their own financial security. Both parties should fully understand the terms of the guarantee and the risks involved, including the potential for financial strain or asset loss.
Seeking legal and financial advice is crucial before proceeding with a guarantor home loan. Both borrowers and guarantors need to ensure they understand their obligations and the potential risks. A well-structured guarantor home loan can be a beneficial arrangement, but it requires careful planning and consideration to avoid future complications.
Conclusion
A guarantor home loan can be an effective way for Australians to secure a home loan, especially for first-time buyers or those with limited savings for a deposit. By involving a guarantor, borrowers can access more favourable loan terms and avoid LMI costs. However, it’s important to carefully weigh the risks and responsibilities before entering into such an agreement.
Both borrowers and guarantors need to understand the financial and legal implications of a guarantor home loan. With the right planning and advice, it can be a beneficial arrangement, but it requires careful consideration of each party’s financial circumstances. Always seek professional advice to ensure a guarantor home loan is the best option for your situation.