Everything you need to know about guarantor loans

Acting as a guarantor is one of the most practical ways a parent or family member can help you on the path to property ownership.

If you're struggling to get a deposit together, a guarantor home loan might be exactly what you need.

What is a guarantor home loan?

A guarantor home loan is one in which a third party, usually a close family member of the borrower, offers an additional security to support the loan.

This security commonly comes in the form of equity in their own property. Some lenders allow the likes of a cash guarantee, usually consisting of funds within a term deposit.

In the event the borrower defaults on their mortgage, the lender could chase the guarantor to repay the loan. If the guarantor also can't pay, the lender could claim the additional securitised asset owned by the guarantor, as well as the original property, to recoup its losses.

From the lender's point of view, this makes the loan less risky. For that reason, borrowers who use a guarantor often don't need to pay Lenders Mortgage Insurance (LMI) and may be able to access lower interest rates.

Guarantors can also choose to only guarantee a portion of the loan (say, 20%) rather than all of it. Once the borrower has repaid the guaranteed portion of the loan, the guarantor can ask to be released from the loan.

Guarantor home loan requirements in Australia

If you choose to go down the guarantor path, your chosen guarantor will need to meet the requirements of the mortgage lender you're applying to. Common requirements for a guarantor include:

• The means to cover the guaranteed loan amountThis might mean the guarantor is required to have sufficient equity in their own property, or put cash into a term deposit, in order to act as a guarantor

• A stable incomeA guarantor must be able to afford the repayments on a mortgage if the borrower were to default

• An acceptable personal credit rating

• An Australian citizen or a permanent resident

• Over 18 years old but below 65 years old Some lenders won't accept older people or retirees as guarantors

• If the guarantor is using equity in a property they own, the property needs to be in Australia

Which lenders offer guarantor home loans in Australia?

Many lenders allow a borrower to add a guarantor onto their home loan application. Here are just a few:

• Commonwealth Bank

• Westpac

• ANZ

• NAB

• BOQ

How much can you borrow with a guarantor loan?

The portion of a mortgage secured by a guarantor can be a slither of the borrowed funds or the entire loan amount.

A lender will generally add the value of the guarantor's commitment to the value of the property under mortgage, thereby reducing a borrower's loan to value ratio (LVR).

Let's use an example:

If you were to borrow $450,000 to buy a property worth $500,000, you would expect to have a 90% LVR. Most lenders demand a borrower pays LMI if their LVR is higher than 80%.

However, if you parents were to agree to guarantor your mortgage, using $100,000 of equity they hold in their own property, you could end up with a lower LVR.

Since the lender now has $600,000 of security (the $500,000 property and the $100,000 guarantee), the borrower's LVR would drop to around 75%.

A borrower with a guarantor can sometimes even borrow more than the value of a property, typically up to 105%.

Some lenders may still require such a home buyer to put down some form of deposit, typically at least 5%, to demonstrate genuine savings.

See also: Can you buy a home without a deposit?

Benefits of using a guarantor

There are several reasons that turning to a guarantor could benefit a homebuyer. Some include:

Eliminate Lenders Mortgage Insurance (LMI)

Lenders Mortgage Insurance (LMI) is an expense borrowers typically need to pay when taking out a higher risk loan. In general, borrowers with an LVR of 80% or more will be charged LMI.

If using a guarantor brings you under that threshold, it could save you thousands of dollars.

In the above example, using a guarantor took our figurative borrower's LVR from 90% to 75%. That could see them avoiding an LMI premium of about $8,680, according to Your Mortgage's LMI calculator.

Lower interest rates

A lower LVR can also provide access to more competitive interest rates.

Many lenders have tiered rates available to borrowers with various LVRs. Typically, the lower the LVR, the lower the rate.

Looking for a low-rate home loan? Check out these options

Risks of taking out a guarantor home loan

While using a guarantor can boost to your home loan application in a big way, you'll also need to consider the risks associated with doing so.

Namely, if you fail to make your repayments, your guarantor will become legally liable for the loan. For that reason, being a guarantor is a major commitment for the person undertaking that responsibility.

Your parents might agree to step up and offer equity in their home to help you buy your own, but if you default on your mortgage, they might be forced to sell their property to pay off your debt.

That type of thing can permanently ruin relationships, which are so often far more valuable than money.

Turning to (or agreeing to be) a guarantor is definitely not to be taken lightly.

What happens if the guarantor can't pay?

In the event a guarantor doesn't have the equity or savings to cover an outstanding debt, they could apply for another mortgage on their property or take out a personal loan.

Only after both avenues have proven to be dead ends will the bank sell their property, and it will only take enough of the proceeds to cover the loan up to the guaranteed value. The rest of the sale's proceeds will go to the guarantor themselves.

Removing a guarantor

Once a borrower pays off the guaranteed portion of a home loan, they may be able to revoke the guarantor's responsibility. In such cases, the following conditions can apply:

• The borrower must be able to make repayments without assistance

• The principal amount of their loan must be less than 80% of their property's value

• They must have not missed any repayments within the last six months

How to be a guarantor

If you're on the other side of the equation and someone has asked you to be their guarantor, you'll need to consider whether your finances are up to scratch.

Before you say yes, you should consider the following:

• Will you be able to comfortably pay off the loan in the event of a default?

• How confident are you that the borrower will be able to meet their repayment obligations?

• How much of the loan do you want to be a guarantor for? This is the maximum amount you will be liable for, so you should cap it at an amount you are comfortable with.

• Will the guarantor arrangement impact your future plans? It might be more difficult to borrow against your property while a portion of your equity is being used as security for another loan, for example.

If you decide to go guarantor, some insurance providers offer policies designed to repay the guaranteed portion of a loan in the event of your death or permanent disability.

What happens if the guarantor sells their home?

If you put up equity in your own property as a guarantee and later decide to sell, the lender may allow you to remain a guarantor and use a form of cash as security instead.

If you guaranteed a property up to the value of $100,000, for instance, you might be able to provide the lender with a $100,000 term deposit to act as security.

Alternatives to using a guarantor

There are other options for aspiring homebuyers struggling to put together a deposit who don't have the option of turning to a guarantor.

Alternatives include:

Government initiatives

Under the Home Guarantee Scheme, the federal government acts like a guarantor for a portion of a home loan to help eligible borrowers avoid LMI premiums.

The First Home Guarantee, as the name suggests, offers support for first home buyers, guaranteeing up to 15% of the property value. There are 35,000 places each year until at least 2025.

There are also 10,000 places offered under the Regional First Home Buyer Guarantee, which also sees up to 15% of a property's value guaranteed by the government.

For eligible single parents or legal guardians, there are 5,000 spots each year under the Family Home Guarantee, which can guarantee up to 18% of the property value.

A buyer might also be able to enter the market through the planned Help to Buy scheme, which could see the government buying up to 40% of a property alongside an eligible buyer.

Low deposit home loans

Alternatively, many lenders allow borrowers to take out loans with a small deposit.

Most of the major lenders offer home loans with a maximum LVR of 95%, meaning you would need a deposit of just 5% of the property value.

These loans typically have higher interest rates and often will need LMI premiums.

This article was originally written by Geraldine Grones and last updated by Harry O'Sullivan in June 2024.

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