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According to the Australian Bureau of Statistics (ABS) the average loan size in Australia has grown to $593,000. In NSW, it’s more than $748,000, and pulling together the money for a deposit has become quite a challenge, particularly for first-home buyers.
With most lenders, a borrower with less than a 20% deposit will be required to take out Lenders Mortgage Insurance (LMI), potentially adding tens of thousands of dollars required to be saved by new borrowers.
It can be really hard to get the money together for even an average deposit for a home. This is where your parents, or another family member, can step in to help you out.
Guarantor home loans are one way to help reduce the deposit required and therefore the LMI. They work by allowing a family member or close friend to use their own property as security for your loan, with that person guaranteeing a portion of it.
It’s important to remember that these loans come with their own risks, so it’s wise to do your research before committing to one. So let’s look at some basics:
What is a guarantor?
A guarantor is someone who agrees to pay the borrower’s debt if you, the borrower, become unable to do so.
This person guarantees that the loan will be paid back to the lender if the borrower defaults.
Who can be one?
People who are prepared to become your guarantee are usually immediate family members, most likely parents or grandparents. Different lenders will have various policies around who is allowed to be a guarantor.
How does it work?
A guarantor home loan is a loan that is secured by the equity in another individual’s property, such as their home. In this case, this would be the equity in your parent’s home. Considering the significant savings FHB’s need, the rise of guarantor loans has been a welcomed solution. Many of the major banks and mortgage lenders now offer guarantor loans, enabling Aussies to get into their own home with less saved up for a deposit.
A guarantor agrees to be financially responsible for the loan or a portion of the loan.
They do not need to hand over funds to the lender or be involved for the entire length of the loan – it is usually for a few years as you pay back the agreed amount.
A security guarantee is often used to help lower the LVR (loan-to-value ratio) below an 80% borrowing threshold so that the borrower can avoid paying LMI.
A loan using a family guarantee is usually set up as two separate loans: One loan is for the majority of the property and is secured by the home you are purchasing. The second loan is for the remainder of the property value and is secured by the home you buy and by some of the equity in your guarantor’s property.
Once you have paid off the smaller loan, you may apply to remove the guarantee. This means that your guarantor is only liable for the time it takes to make those initial repayments. The steps vary but the lender will carry out a valuation and review your financial situation before releasing or refinancing the property.
It is possible to remove the guarantor earlier but this varies from lender to lender and situation to situation. Of course, if your mortgage is still over 80% of the property’s value, you will need to pay LMI.
Let’s look at the Pros and Cons
Guarantor home loans can be a useful financial tool for individuals who may not have a strong credit history or a substantial down payment to purchase a home. However, like any financial arrangement, they come with both risks and benefits. It’s important to carefully consider these factors before deciding whether a guarantor home loan is right for all parties involved.
Benefits of Guarantor Home Loans
Better serviceability: Having a guarantor can help you qualify for a mortgage you might not otherwise be eligible for due to limited income or a weak credit history, ie. It can help you take out a larger loan amount.
Lower Interest Rates: With a guarantor, you may qualify for lower interest rates and better loan terms compared to those you might get on your own.
Lower or No Down Payment: Some guarantor loans allow borrowers to purchase a home with little to no down payment, making homeownership more accessible.
Faster Loan Approval: The presence of a guarantor can speed up the loan approval process, as lenders may be more willing to lend to you when there’s a guarantor involved.Risks of Guarantor Home Loans
Financial Responsibility: The primary risk for guarantors is that they become financially responsible for the loan if you fail to make your repayments or default. When a guarantor signs on to a loan, they agree to cover the entire debt if the borrower defaults, regardless of the original proportion of the loan they agreed to guarantee. However, being a guarantor does not typically grant them any ownership rights to the property purchased with the loan.
Impact on Credit: Both your and your guarantor’s credit scores can be negatively affected if the loan goes into default.
Property Risk: If the guarantor has put up their property as collateral, they are risking their own home if the borrower defaults.
Limited Financial Flexibility: Guarantors may find it more challenging to secure their own loans or credit in the future since they are already financially tied to the borrower’s mortgage.
Legal Obligations: Guarantor agreements are legally binding, and guarantors may face legal action if they fail to fulfill their obligations.
Strained Relationships: If the borrower struggles to make payments or defaults, it can put a significant strain on the relationship between the borrower and the guarantor, often a family member or close friend.
Is a Guarantor Home Loan right for your situation?
Before entering into a guarantor home loan agreement, it’s crucial for both the borrower and the guarantor to thoroughly understand the terms and implications.
Consulting with a financial advisor or attorney can also be vital to ensure that all parties involved are fully informed and protected.
If parents want to help, but you aren’t willing to enter into such a loan, alternatives such as accepting a one-off cash gift, purchasing the property yourself further down the track when you’ve had time to improve your creditworthiness or save for a larger down payment, or using the first home loan deposit scheme might suit you and your family better.
It’s always a good idea to consult with a qualified professional to fully explore your financial situation and pathways towards property ownership. A broker can help you sift through the options that might be available to you now or in the future.
