Building enough for a deposit is often the first step many aspiring homeowners take before getting on the property ladder. It is also the most challenging step as the deposit amount, typically set at 20% of the property’s value, can easily reach six figures – especially with current home prices on the rise.
Some home buyers may struggle to come up with sufficient funds for a deposit, but this does not necessarily mean their dreams of homeownership are over. In some instances, a family member may be able to help them secure a home loan by acting as a guarantor.
What does it mean to be a guarantor on a home loan?
A guarantor is someone who guarantees another person’s loan or mortgage. Banks and lenders have different criteria on who can act as one, but generally they allow an immediate family member, often a parent or sibling over the age of 18. Some lenders allow a legal guardian or a close relative, including uncles and aunts, to act as a guarantor.
If you agree to become a guarantor, you will be responsible for paying a family member’s mortgage in the event they fail to make repayments. You may also be asked to offer equity from your property as a form of security for the home loan.
What are the risks of guaranteeing a home loan?
While acting as a guarantor allows you to help someone you care about achieve their homeownership goals, it does not yield any financial benefits for you. It also exposes you to several risks because of the level of responsibility involved.
If you are considering going guarantor, it pays to practice the same due diligence as if you were taking out the home loan yourself. Here are some possible risks associated with being a guarantor:
1. You may have to pay off the remaining loan amount.
One of the biggest risks of acting as a guarantor is that you will be held liable in the event the borrower is unable to meet their monthly mortgage repayments. This means you will need to pay off the remaining loan balance or at least the portion of the loan you guaranteed. If you are not able to this, you may be forced to sell your property or other assets that you used as security to repay the debt.
2. It can negatively impact your credit report.
Guaranteeing a home loan does not necessarily impact your credit history. However, if the borrower defaults on the loan and you are unable to step up and meet the repayments, the default will appear on your credit report. This is the reason why you need to make sure your finances are set, and you can afford to make the repayments before agreeing to become a guarantor.
3. It can affect your chances of taking out a loan.
Credit providers often consider a guarantor loan as a liability when assessing your application even if you are not the one making the repayments. This significantly impacts your chances of getting approved for a loan.
4. It can damage your relationship with a family member.
Before going guarantor, you need to honestly ask yourself whether you trust this family member to be financially responsible. Bear in mind that your relationship can be strained if you end up paying for the loan or losing your home because you fail to cover for the monthly repayments.
What are the things you need to consider before agreeing to be a guarantor?
Acting as a guarantor for someone else’s loan is a major commitment that requires careful planning and preparation. Here are the most important things you need to consider before agreeing to guarantee a family member’s home loan:
1. Size of the loan
Carefully assess your financial situation to determine your capability to meet the repayments if the borrower fails to do so. Work out the total amount you would have to pay off, which may include interest rates, fees, and other charges. Make sure you can cover the monthly repayments without outside help.
2. Terms of the loan
Check out the timeframe needed for the loan to be paid off. A longer loan term may mean lower monthly repayments but often comes with a higher interest rate. If possible, it is best to limit your guarantee in terms of amount and time.
If you are being asked to guarantee a business loan, make sure to learn everything you can about the company involved – including its financial status – before deciding.
3. Loan security
If you are acting as a security guarantor, you may need to use an asset – such as your house or car – as security. This means that if the borrower defaults on the loan, the lender can repossess these assets to pay the debt.
How can you reduce the risks of being a guarantor?
Although there are many risks involved with being a guarantor, there are ways to help mitigate them.
One is seeking independent legal and financial advice to make sure you understand the loan process and its impact on your financial situation. The agreement that you sign should be clear on the extent of your liability and responsibilities in the event the borrower defaults. It is also advisable for you to get guarantor protection in the form of insurance coverage. Even though those involved in the process are family members, you should be able to treat being a guarantor as a business agreement.
You can also explore other options to help family members purchase a home. An alternative is giving them a one-off gift payment, which can help cover the cost of a deposit. If the borrower is a first home buyer, they can also avail of the government’s First Home Loan Deposit Scheme, allowing them to purchase a property for as little as 5% deposit without having to pay lender’s mortgage insurance.