Buying your first home can be a big financial challenge. During your home buying journey you may think about asking a family member to help you out. But how exactly can they do this – and what are the potential consequences if they do?
WHAT IS A GUARANTOR?
A guarantor can help you secure a home loan by offering their own property (or properties) as security for your loan. Say, for example, your parents have paid off their mortgage over the years and have built up equity in their property. By agreeing to allow the equity in their home to be used as security for your home loan, they become your guarantors.
WHO CAN ACT AS GUARANTOR?
Home loan guarantors are generally limited to immediate family members such as parents and spouses, although some lenders may also allow siblings, parents-in-law, step-parents, grandparents and even aunts and uncles to act as guarantor for you.
WHAT ARE THE ADVANTAGES OF HAVING A GUARANTOR?
The advantage of a guarantee is that it helps you get into your new house sooner and reduces or avoids Lenders Mortgage Insurance (LMI) without having to have a big deposit – for example if you were to purchase a property for $600,000 and borrowed the maximum allowable around 95% of the purchase price your mortgage insurance will be approximately $27,5000 – without a guarantor in order to avoid lenders mortgage insurance you would need to come up with a 20% deposit plus stamp duty and legal fees this would require an approximate deposit of $145,000 based on a $600,000 property purchase –
Other benefits include.
- Being able to maximise the amount you can borrow so you can get into your home faster
- Unlock better loans with more favourable rates
- Releasing the guarantee when the guarantor requests this once you’ve reduced the loan amount
- secured by the guarantee— your family member won’t be liable forever!
- You can limit the size of the guarantee to reduce your guarantors liability.
WHAT ARE THE DISADVANTAGES/RISKS OF USING A GUARANTOR?
If you have a family guarantee and you end up being unable to make your loan repayments when they are due, the bank may look to your guarantor (your family member) to pay the guaranteed portion of your loan. In a worst-case scenario, your guarantor may need to sell their own property to repay your home loan. This may mean your parents having to sell their own home. It is really important for your guarantor to get independent financial and legal advice before they enter into their guarantee so that they understand all their obligations and the pitfalls
REMEMBER: IT’S A LIMITED GUARANTEE
What if in the worst case scenario your property is sold but it isn’t enough to cover the home loan? Something that usually gets glazed over is the fact that a guarantor loan is a ‘limited guarantee’ meaning that the guarantor is only liable to cover up to an agreed amount, usually around 20% of the purchase price plus the costs of completing the purchase, depending on the lender. For example, if the outstanding debt is for $600,000 but your limited guarantee is for only $140,000, you’re guarantor is only liable to cover the outstanding mortgage up to $140,000. So if your property only sells for $400,000, your guarantor will have to cover up to $140,000 with equity in their property but they won’t be liable for the $60,000 shortfall. If the property sells for $590,000 you would be liable for $10,000. If the property sold for $600,000 you would not have to worry about anything.
ARE THERE ANY ALTERNATIVES TO GUARANTORS?
There may be other ways for guarantors to help a family member without putting their home or saving up as security.
- Co-borrow with you: Your parents or other family members or friends might prefer instead to co-sign the home loan with you. That way you’re both jointly liable for the debt but their exposure will be limited to the property you are purchasing together. On top of this they’ll also have a stake in that property’s growth potential.
- Chip in with the deposit: A potential guarantor may be able to help you out with your deposit. They might, for example, gift you a lump sum of money or agree to loan it to you interest-free so you can repay it to them over time. If they can give you enough to reach a 20% deposit, your loanto- value ratio (LVR) should be such that you’ll avoid having to pay LMI.
- Let you live at home: Paying rent will always be one of the biggest impediments to saving. Your family may be willing to let you move back home (or stay living at home longer than originally planned) to help you save.