The main issue for many first-time homeowners and investors in the current property market is the ability to save a deposit.
Pulling together a big enough deposit remains a struggle for many would-be property buyers, especially when they have to pay for their living costs, including rent, at the same time.
While house prices have moderated due to Covid-19, previous years of strong growth that proceeded these softer market conditions means prices remain high for first home buyers.
However, with interest rates at historic lows, the ability to afford mortgage repayments once you’re in the market has improved significantly.
One way to get a start on the property ladder sooner is by using guarantor home loans that can help get more prospective buyers into their first property.
What is the structure of guarantor home loan?
Guarantor loans can be a great way for young people to achieve a deposit, but their ins and outs must be understood from the outset.
- A guarantor loan works by someone else (more on that a bit later) providing equity or security in their property to fund part, or the whole, deposit.
- A guarantor loan requirement is sufficient equity in the property offered as security.
- A guarantor doesn’t need to be involved in the loan for its entirely. Instead, it’s advisable that the property owner actually works towards getting the guarantor “released” from the loan, which can be achieved by paying down the mortgage or improving the property via renovations and therefore increasing its value.
- A guarantor is a person or persons who assumes responsibility for paying off the loan if you’re no longer able to meet your financial commitment. Essentially, the guarantor takes financial responsibility for servicing the home loan in the event that you default on your repayments. Even if the guarantee is only for 20 per cent of the entire loan, the guarantor will be wholly and severally responsible for the loan but doesn’t have ownership rights to the property.
The most common types of guarantee are:
Servicing Guarantee – Where the guarantor supports the borrowers loan facility with their income, and;
Security Guarantee – Where the guarantor offers additional security, such as part of the equity in the family home, to provide adequate security to the lender for their loan requirements.
A security guarantee is the most common and often used to help lower the loan-to-value ratio (LVR) below an 80% threshold thus allowing the borrower to avoid paying lender’s mortgage insurance (LMI).
The upside of the facility is that the guarantor doesn’t need to physically hand over any funds to the lender at the time of the approval.
Instead, they simply assure the lender they will cover the shortfall if the borrower defaults.
Of course, for the facility to work, the guarantor must have sufficient equity in assets offered as security.
Guarantor home loans do require a number of checks and balances, however working with an expert finance broker will help smooth the process.
An example of how a guarantor loan can work is:
John and Jill want to buy a $750,000 home but have struggled to save a big enough deposit. In fact, they have only managed to save enough to pay the stamp duty and associated costs. As newly-weds, they approach John’s parents who have paid off their own home, who then agree to use $150,000 of their own equity to finance the required 20 per cent deposit for the couple.
Who can be a guarantor?
The main consideration with guarantor home loans is that they must be provided by someone who has a strong relationship with the buyer or buyers, which generally means immediate family members such as:
- Parents
- Siblings
- Grandparents
- Spouses
- De facto partners.
It’s not the case that ‘just anyone’ can act as a guarantor.
The rules stipulate there must be a link between the guarantor and the guarantee, and there must also be a financial benefit for the party offering the guarantee.
Family guarantors are common because of the obvious link.
Among the usual parties acting as guarantor are parents, siblings, grandparents, spouses and de factor partners.
The financial benefit to family members is that they don’t need to dispose of their own asset in order to assist their relative (e.g. a child).
Instead, the guarantee means they can put up equity while still retaining ownership and control of that asset.
Another way to look at is that it’s a way for a parent to pay forward some future ‘inheritance’ without penalising them financially in the present.
Another guarantor/guarantee relationship is one around legal entities such as a companies or trusts.
In this case, the entity itself may not have sufficient assets to qualify for a loan, however those linked to the trust or company do.
In this situation, a company director or trustee guarantees the legal entity’s loan arrangement.
There are a number of considerations for guarantor home loan requirements that the lender will take into account.
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These include:
- Their age
- Whether their property is in Australia
- If they have sufficient equity
- Whether they are currently employed
A guarantor also needs to be of sound mind and will need to seek both legal and financial advice before making the decision to act as a mortgage guarantor.
How much can you borrow?
While the lending environment remains tight, there are more loan products on the market now that suit first home buyers.
These are generally loans that offer higher loan to value ratios (LVR), which ultimately means that the deposit can be lower.
For example, there are loans which require only a five to 10 per cent deposit, which makes it easier to save the required amount.
On top of that, many first-timers might then use a guarantor to increase the deposit to 20 per cent of the purchase price which will remove the requirement to pay Lenders Mortgage Insurance or LMI.
In fact, by using a guarantor home loan, lenders are generally more flexible with their lending criteria, which means that prospective property buyers can usually access loans with LVRs in the 90 per cent range.
Of course, guarantor home loans do require a number of checks and balances, such as a requirement that you hold documentation for three days that will mean you have been deemed to have read and understood the requirements.
The risks of going guarantor
The primary risk of going guarantor is if the borrower defaults on the loan arrangement, you are legally required to make repayments, or cover the outstanding loan amount.
This means the lender may choose to foreclose on that guarantee asset and sell it in order to recoup their losses.
The best way to mitigate this risk is simply through due diligence.
Even when going into bat for your own kids, do a level-headed assessment of their ability to continue meeting their requirements before choosing to risk your own financial security.
Another consideration is that if you are guarantor on a loan facility, this encumbrance will be factored in as part of any loan application you make for yourself.
Whether it be a servicing or security guarantee, your own lender will be assessing the effect of that commitment and its potential risk as part of their processes.
How is a guarantee released?
A guarantor doesn’t need to be involved in the loan for its entirely.
Instead, it’s advisable that the property owner actually works towards getting the guarantor “released” from the loan.
Releasing a guarantor is not a difficult process, and often occurs in response to two scenarios:
- Increasing equity in the principal property – Say the guarantee was used to help a family member avoid LMI by introducing security that lower the LVR to 80% or less. If, after a year or two, the value of the home increases and/or the outstanding balance of the loan decreases to the point that the LVR reaches a below-80% threshold regardless of the guarantee security, then the guarantee can be released.
- Refinance – If the prime borrower refinances the property with a new lender who does not require the guarantee, the security can be released as part of the normal refinancing process.
Keep this in mind too – the borrower’s financial situation will probably change over the coming years.
They may receive a pay rise or build another asset base.
Multiple events can occur which eventually render the guarantee unnecessary, and arrangement can be made at any time to release the beholding party.
How to find and compare guarantor home loans
The home loan market is broad and diverse, and most lenders offer the guarantee facility across most, if not all, of their products.
Also, having a guarantor doesn’t affect the basic terms of a loan, such as the interest rate.
It’s more about assisting the outcome of the loan application.
That means your primary goal is to first choose a loan facility that provides the best terms and conditions for your particular situation.
Once you’ve unearthed your ideal loan, it’s a matter of discussing the use of the guarantee as part of the application process.
But selecting the right loan for you can be challenging without the assistance of an experienced mortgage broker.
The world of banking can be a pretty daunting one for both novice and sophisticated investors, and since our establishment in 2002 we’ve focused on providing outstanding service and business standards.
This approach was vindicated when we were named Victoria’s favourite mortgage broker at the Investors Choice Awards.
