The dream of homeownership is a common thread that binds us all. Yet, the financial commitment involved can often seem overwhelming. For many Australians, guarantor home loans have provided a path to achieving this dream. In this comprehensive guide, I’ll delve into the details of guarantor home loans, covering their benefits, potential downsides, and several essential considerations for both borrowers and guarantors.
What is a Guarantor Home Loan?
A guarantor home loan is a type of mortgage product that enables a third party, typically a family member, to guarantee a portion or all of the loan amount. This guarantee reduces the lender’s risk, often making it easier for the borrower to secure a loan. A guarantor home loan can provide numerous benefits, such as helping borrowers purchase a home without needing a substantial deposit or enabling them to avoid paying Lenders Mortgage Insurance (LMI).
LMI is a one-off insurance payment that borrowers usually need to pay if they’re borrowing more than 80% of the property’s value. It’s a safety net for lenders in case the borrower can’t repay the loan. However, it can add a substantial cost to the home loan, so avoiding it can result in considerable savings.
The Pros and Cons of a Guarantor Home Loan
Before embarking on a discussion about who can act as a guarantor and what this responsibility entails, it’s important to examine the advantages and disadvantages of guarantor home loans.
Advantages
- No or Low Deposit Required: One of the most notable benefits of a guarantor home loan is that it may enable the borrower to secure a mortgage without needing a deposit. This can be particularly advantageous for first-time homebuyers who may struggle to save a sufficient deposit while also covering the cost of living.
- Avoiding LMI: With a guarantor providing additional security for the loan, the lender may waive the LMI, resulting in significant cost savings for the borrower.
- Increased Borrowing Capacity: Having a guarantor may increase the amount a borrower can secure, enabling them to purchase a more expensive property or cover additional costs like stamp duty or renovations.
Disadvantages
- Potential Risks for the Guarantor: The guarantor is legally responsible for covering the loan repayments if the borrower defaults. This could put their own assets at risk and potentially lead to financial hardship.
- Reduced Equity for the Guarantor: A guarantor’s equity will be tied up in the guarantor home loan, potentially limiting their ability to borrow money for their own needs.
- Future Loan Implications for the Borrower: If a borrower’s circumstances change in the future, such as wanting to invest in additional property or upgrade their home, these decisions could be complicated by the existence of the guarantor loan.
Who Can and Cannot Be a Guarantor?
Generally, guarantors are immediate family members, with parents being the most common. However, in some cases, siblings or even grandparents may act as guarantors, although this is less common and may come with stricter conditions. Friends or non-relatives are rarely accepted as guarantors due to the increased risk involved.
To be a guarantor, an individual must be an Australian citizen or permanent resident, have a stable income, and have sufficient equity in their property. They must also fully understand the implications and risks of being a guarantor, and be willing to accept the financial responsibility if the borrower defaults.
Conversely, individuals who are not financially stable, who have a poor credit history, or who do not have sufficient equity in their property will likely be unable to serve as a guarantor.
Maximum Borrowing Amount for Guarantor Home Loans
The maximum borrowing amount for guarantor home loans depends on several factors, including the lender’s policies, the borrower’s financial situation, and the value of the guarantor’s property. In some cases, a borrower may be able to secure up to 105% of the property’s value. This can include the purchase price plus additional costs such as stamp duty and conveyancing fees. However, each situation is unique, and it’s crucial to discuss this with your lender or mortgage broker to fully understand your borrowing capacity.
The Risks of Being a Guarantor
Acting as a guarantor involves significant responsibility. If the borrower defaults on the loan, the guarantor is legally required to meet the loan obligations. This could potentially put the guarantor’s property at risk, especially if they need to use it as collateral to cover the loan repayments. Moreover, it could impact their credit rating, especially if they’re unable to make the repayments, and it could limit their borrowing capacity in the future.
Being a guarantor also involves emotional risks. If the borrower defaults, it could strain the relationship, especially if the guarantor is a close family member. It’s crucial for potential guarantors to consider these risks before agreeing to become a guarantor.
Example of a Guarantor Home Loan
Let’s consider an example to illustrate how a guarantor home loan works.
Suppose Alice, a first-time homebuyer, wants to buy a property worth $500,000. However, she only has $25,000 saved for a deposit, which is less than the typically required 20%. Without a guarantor, Alice would need to save $100,000 for a 20% deposit or pay LMI on a loan with a smaller deposit.
Alice’s parents offer to act as guarantors. They own their home outright, which is valued at $800,000. Their home is used as security for Alice’s loan, which gives the lender confidence to lend Alice the full amount needed to purchase the property, despite her small deposit.
In this case, Alice can buy the property without saving a larger deposit or paying LMI. Meanwhile, her parents’ liability is limited to the agreed guaranteed amount (typically the difference between Alice’s deposit and the required 20%, i.e., $75,000).
However, if Alice fails to make her repayments, her parents would be liable to cover the repayments on her behalf, up to the guaranteed amount. This responsibility could put their own home at risk if they’re unable to meet this obligation.
In conclusion, a guarantor home loan can open doors for homebuyers who might otherwise struggle to secure a mortgage. However, the implications for both the borrower and the guarantor are significant and should be fully understood before entering into such an agreement. It’s always recommended to seek professional financial and legal advice to ensure you make an informed decision.
Things to Consider If You Want to Act as a Guarantor
If you’re considering acting as a guarantor for a home loan, there are several key factors to take into account:
- The Financial Stability of the Borrower: Assess the borrower’s ability to meet the loan repayments. This includes considering their income stability, their other financial obligations, and their history of managing debt.
- Your Own Financial Position: Consider whether you would be able to manage the repayments if the borrower defaults. This involves looking at your own income, your other financial commitments, and your future financial needs.
- Legal Implications: It’s crucial to seek independent legal advice to understand the legal implications of being a guarantor. This includes understanding the terms of the loan agreement and the potential consequences if the borrower defaults.
- Future Borrowing Capacity: Being a guarantor can affect your ability to borrow money in the future, as lenders will consider the guaranteed loan as a liability.
- Exit Strategy: There should be a clear plan for when and how you’ll be released from the loan. This could be once the borrower has paid off a certain percentage of the loan, or if the property has increased in value to a certain point.
Requirements to be a Guarantor
While the specific requirements for a guarantor may vary between lenders, there are a few common prerequisites:
- Property Ownership: Most lenders require guarantors to own property in Australia, which can be used as security against the loan.
- Stable Income: Guarantors must have a stable income to demonstrate that they could cover the loan repayments if necessary.
- Good Credit History: Guarantors are typically required to have a good credit history, which shows that they have been reliable borrowers in the past.
- Legal Capacity: Guarantors must be of legal age and have the mental capacity to understand and agree to the terms of the contract.
- Independent Legal Advice: Many lenders require guarantors to seek independent legal advice before signing the loan agreement. This is to ensure that they fully understand their obligations and the potential risks involved.
Does Being a Guarantor Affect My Credit Score?
Becoming a guarantor does not directly impact your credit score. However, if the borrower defaults on the loan and you are unable to cover the repayments, this will be recorded as a default on your credit report. This can negatively affect your credit score and your ability to borrow money in the future. It’s essential to consider this potential impact before agreeing to become a guarantor.
Guarantor with an Existing Home Loan
If your potential guarantor already has a home loan, they may still act as your guarantor, given they have enough equity in their property and can demonstrate the financial capacity to meet both their own loan repayments and yours if you default. However, this could limit the amount they can guarantee and potentially impact their ability to borrow further for their own needs.
Lenders assess the guarantor’s financial situation, including their current debts and obligations, before accepting them as a guarantor. This is to ensure they are financially capable of taking on the additional responsibility. As such, it’s crucial for the guarantor to consider the potential implications on their financial position carefully.
Duration of a Guarantor on a Home Loan
A guarantor stays on a home loan until they are officially removed from the loan agreement. As previously mentioned, this typically happens when the borrower has paid off a certain percentage of the loan or when the property has sufficiently increased in value.
The timeframe varies and could range from a few years to over a decade, depending on the size of the loan, the repayment schedule, and the property’s appreciation rate. It’s worth noting that being a guarantor is usually a long-term commitment, and potential guarantors should be prepared for this.
Understanding the Loan Agreement
Before agreeing to become a guarantor, it’s crucial to fully understand the loan agreement. This includes knowing the total loan amount, the repayment schedule, and what happens if the borrower defaults. You should also understand what your responsibilities are as a guarantor and what the potential consequences are if you can’t meet these responsibilities.
It’s a good idea to seek independent legal advice to help you understand the loan agreement. A lawyer can explain the terms of the agreement, answer any questions you have, and ensure that you fully understand the potential risks and liabilities.
Communication is Key
Clear and open communication is crucial when entering a guarantor agreement. Both the borrower and the guarantor need to have a frank discussion about their financial situations, their expectations, and their plans for the future. They should also discuss what will happen if the borrower can’t make the repayments, and ensure that they are both comfortable with the plan.
It’s also important to keep the lines of communication open throughout the term of the loan. The borrower should keep the guarantor updated on any changes to their financial situation, and the guarantor should feel comfortable asking the borrower about their financial situation.
Conclusion
A guarantor home loan can be a powerful tool to help Australians achieve their dream of homeownership. However, it’s not a decision to be taken lightly. Both borrowers and guarantors need to fully understand the benefits, potential pitfalls, and long-term implications before proceeding.
For borrowers, the benefits of potentially not needing a deposit, avoiding LMI, and having increased borrowing capacity need to be balanced against the potential complexities of future borrowing scenarios and the pressure it may place on their relationship with the guarantor.
For guarantors, it’s crucial to consider the borrower’s financial stability, your own financial and legal position, the impact on your future borrowing capabilities, and the potential strain on your relationship with the borrower.
In all cases, seeking professional financial and legal advice is highly recommended to ensure that all parties involved make informed decisions. After all, purchasing a home is a significant investment, and it’s essential to enter into it with a full understanding of the implications. By doing so, the journey to homeownership can be a positive and rewarding experience.
