One of the most common types of guarantor for home loans is a security guarantor. This means that instead of giving the borrower money to put towards the deposit, you give the equity that is saved in your property. Therefore, the loan is secured using both the property being purchased and your property. This will usually help reduce the borrowing amount to less that 80% of the purchase price so the borrower can avoid paying lenders mortgage insurance.
While being a guarantor helps the borrower substantially, there are actually no direct financial rewards for you, the guarantor. But there is a lot of responsibility involved. If the borrower is unable to afford the repayments down the track, you will be responsible for paying off the remaining amount of the loan or having to sell the property you used as security to repay the debt.
Some possible risks involved with being a guarantor include:
Default on your credit report
Guaranteeing a home loan doesn’t affect your credit report by itself. However, if you are required to step up and make the repayments on the loan, but are unable to, this default will appear on your credit report. Therefore, before signing to be a guarantor, you need to ensure you can afford the repayments.
May not be able to get credit
It is important to remember that even if you are not making repayments on the loan you’ve guaranteed, if you apply for credit, the credit provider will include this loan as a liability when assessing your application. As a home loan is usually a significant amount of money, being a guarantor could significantly affect your chances of taking out a loan.
Cause problems with the borrower
Signing up to be a guarantor may seem like a great idea at the time, but it could cause problems with your relationship with the borrower if you have to end up repaying the loan. Also, if something happens down the track and you have a falling out, you are still legally required to repay the loan. This is why it is vitally important to consider the worst case scenario before agreeing to be a guarantor.
Although there is a lot of responsibility and risk with being a guarantor, there are ways to help reduce these risks:
Seek independent advice: Being a guarantor should be treated as a business agreement, even though family and friends are involved. Often guarantors let emotions get in the way and don’t realise how serious the commitment is. Therefore before signing an agreement, speak to a legal and financial professional by yourself to ensure it is something that you are able to do.
Discuss other options: Being a guarantor is not the only way you can help your children, family member or friend. One option is giving a one-off gift payment which can help cover the deposit partially or fully. This option not only helps the borrower purchase a property, but it also reduces the risk ad ongoing responsibility for you.
Plan for the worst case scenario now: No matter how much you trust the borrower to meet repayments on time; there are some circumstances which we can’t always control, such as illness or loss of job, which can affect the borrower’s ability to afford the loan repayments.
So, before agreeing to be a guarantor for a home loan, take time to research whether you would actually be able to afford the repayments if you had to step up.