Most people know what a home loan is, and understand how it works, but when it comes to a guarantor loan there is a distinctive drop in awareness and understanding. However, this type of loan can be incredibly useful for first home buyers, and for parents who are in a position to help their children with their first home purchase. So let’s dive into what a guarantor loan is, and how it might help you get your foot into the property door.
Guarantor Loan Basics
At its most simple: a guarantor home loan is a type of loan that allows family members or someone else who is close to you, to ‘guarantee’ a loan that you are taking out. They provide a guarantee to the bank that the loan will be paid. This essentially means this person, the guarantor, will be responsible for paying back the loan that you’ve taken out if you can’t. A guarantor is typically a first home buyer’s parents, grandparents, or another close relative, and can either offer up equity from their own existing property, or cash funds as security for part of your mortgage.
It is estimated that around 60% of first home buyers in Australia have Guarantors for their home loans.
Why Have a Guarantor?
There are many benefits to having a parent, guardian, grandparent, or other close relative step in during your loan application process, and be your loan guarantor.
One of the main benefits of having a guarantor on your home loan is that it may help you avoid paying Lenders Mortgage Insurance (LMI). This is a fee paid by the borrower to the lending institution when the borrower cannot provide a 20% deposit on the property they are wanting to purchase. LMI exists to protect the lender against the potential financial loss of the borrower being unable to meet their mortgage repayments. It can be paid upfront as a one-off or added to your loan repayments, depending on the lender. Although it varies lender to lender, most institutions require borrowers to pay LMI on loans where the borrower has a downpayment of less than 20% of the property’s value. If you have a parent guarantee your loan however, you may not need to pay LMI as your parents’ can use their own assets as security.
Additionally, a Guarantor can provide a type of safety net for if you run into issues servicing your mortgage. While we would never suggest relying on another person to cover your costs, if you are someone who does contract work then having a pre-agreed upon support network may help.
Having a guarantor for your home loan doesn’t mean you get out of paying the mortgage, or any of the associated costs of home ownership however-you remain responsible for meeting all of your repayment obligations. It is only if you should fall on hardship or require time out from paying your mortgage for a period due to extenuating circumstances- your guarantor can step in to help out. This is obviously something that needs to be pre-agreed upon with your guarantor.
Did you know there are different types of Guarantees, for Guarantor Loans?
Here are the four most common types of guarantees:
1. Security guarantee
This is the most popular type of guarantor loan; many first time home buyers with an excellent credit history and score but have very little to no deposit often use this type of guarantee. The guarantor, called an “equity guarantor” by some lenders, will leverage existing real estate that they own as security for the first home buyers’ mortgage. Should the guarantor still have a loan on their own property then the lender is able to take a second mortgage as security.
2. Security and Income Guarantee
This guarantee is pretty self explanatory: it’s guaranteeing enough income to cover the loan repayments. Guarantors in this category are most often parents helping their child who is a student or is in a low paying job and therefore has insufficient income to buy a property. The lender will use the parents’ property as security for the child’s loan, and rely on the parents’ income to prove that the loan is affordable.
3. Family Guarantee
As with the one above, this type of guarantee is pretty self explanatory: it is a family member of the loan applicant guaranteeing the loan. In this type of loan all relatives could be considered on a case by case basis, including siblings, spouses, and even de facto partners.
4. Limited guarantee
In this guarantee, as the title suggests, the guarantor only guarantees a part of the loan. This guarantee arrangement provides the least exposure for the guarantor.
Who can be a guarantor?
The requirements to be a loan guarantor varies from lender to lender but generally guarantors should:
- Have equity in their property and/or a stable income to satisfy lenders;
- Have at least a good personal credit rating;
- Be an Australian citizen or Australian permanent resident; and
- Be above 18 years of age, but below 65 years years of age.
How long does a guarantor stay on a mortgage?
On average, guarantors can stay on your loan from from two to five years. Generally how long they stay depends on a number of factors, the two most important being how quickly you pay down the loan, and the second one how fast your property increases in value.
It is important to note that a Guarantor isn’t automatically removed from your loan after a certain period of time, there is a rigorous refinancing process that needs to be completed.
How do you remove a Guarantor?
Many of the major banks and other lenders follow similar policies when it comes to guarantor loans. A loan applicant becomes eligible to remove the guarantor/guarantee from their home loan once they have achieved some, or all of the below requirements:
- All repayments over the preceding six months were made on time,
- The loan has an LVR (loan to value ratio) of less than 80%, and
- The applicant’s credit history, income, employment, and other situational aspects must meet the lender’s policy.
When is the best time to remove the guarantee?
Although this is a highly personal question that should only really be answered by your financial planner, generally once you owe less than 80% of the value of your property (have an LVR below 80%) you could consider removing your guarantee.
There are several reasons for this, such as:
- You could potentially save thousands through avoiding LMI expenses,
- You may qualify for a lower interest rate as you have a lower LVR, and
- It’s considered a more straight-forward process with less paperwork as you’re less of a high risk applicant for the lender to process.
Opting to have a Guarantor on your home loan application is a big decision, both for you and for your Guarantor of choice. This is not a step to be taken without adequate consideration to the process, and the potential implications of the agreement. It is highly recommended that you consult with a personal financial advisor before electing the type of home loan you go with: whether it be solo, or with a Guarantor.
If you want to learn more about securing a guarantor loan, or removing your guarantor from your loan, book in for a ‘Quick Chat’ with our team here!