It can be difficult for home buyers, particularly those seeking to purchase their first home, to save enough for a significant home loan deposit. Having a guarantor can eliminate this hurdle, helping you to break into the property market sooner rather than later.
What is a guarantor home loan?
Put simply, a guarantor home loan requires a portion of the loan to be backed up by a guarantor. This is generally restricted to immediate family members, such as a parent or guardian, or in some cases, close friends.
It works much like a standard home loan: you borrow money from a lender and repay the amount over time. The key difference is that instead of providing a large deposit yourself, your guarantor uses their own property or assets as security for your loan. This can ease deposit hurdles and slash the time it takes to break into the housing market.
If you find yourself unable to make your loan repayments, your guarantor becomes liable to cover them. If in the unfortunate event they also cannot meet loan repayments, you could lose your home, and your lender could recoup any additional debt owing via the guarantor's home as well.
While guarantor loans often work well, they come with serious responsibilities. If things go wrong, your guarantor may have to step in and repay the loan, which can be a significant financial burden.
Talk about an awkward dinner conversation!
That’s why it’s important to carefully consider who you ask to be your guarantor, and make sure they fully understand the risks involved.
Qualifying to act as a guarantor
Most lenders will generally require a guarantor to be a close family member, such as a parent or partner. But some lenders may allow other relatives to be guarantors, like a sibling or grandparent.
Many banks will have different eligibility requirements for who can be a guarantor, but the following will typically apply:
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Aged between 18 and 65
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Regular and stable income
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Strong credit history with no defaults
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Sufficient equity in their home (typically at least 80%), or they must own their home outright
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There are typically caps on how much of a proportion of equity can be assessed as a guarantee.
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Guarantor's property must be located within Australia
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The mortgages on both properties likely need to be with the same lender, with only a few brands allowing guaranteed loans from other banks and lenders.
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Some lenders might have serviceability requirements on the guaranteed amount, while others do not.
How much can I borrow with a guarantor home loan?
Guarantor home loans can allow you to borrow more than 80% of the property's value without paying LMI - lender's mortgage insurance which could save you thousands. Some lenders even allow you to borrow 100% or even 110% of the property's value if you have a guarantor to back you up.
This means you can potentially buy a home with no deposit at all, and even have some extra to cover costs such as stamp duty, conveyancing, and the first set of strata levies and council rates. Of course, this will heighten your mortgage repayments, so you want to make sure you can afford it - otherwise your guarantor is on the hook.
How a guarantor home loan works
Here’s an example of how a guarantor home loan can work: Simon and Andrea have their sights set on a $600,000 house, yet combining their savings, they have amassed enough for a 10% deposit to put down, equivalent to $60,000.
Given the deposit is less than 20%, Simon and Andrea will be required to pay Lender's Mortgage Insurance (LMI), potentially costing them thousands under normal circumstances.
Thankfully, Simon's parents own their house outright, and so they agree to become guarantors, offering a guarantee for a further $60,000 of the total loan, which brings the deposit up to the required 20%. This means that Simon and Andrea will not have to pay the additional expense of the LMI, which would have resulted in greater monthly mortgage repayments.
To help you identify how much you could potentially save on LMI with a greater deposit, InfoChoice's Mortgage Calculator can help take out the guesswork.
Benefits of guarantor home loans
Here are some key advantages of guarantor home loans that can help make buying a home easier and more affordable.
Enter the property market sooner
For many, the hurdle isn't the mortgage payments, but saving up enough to get their foot in the door. Taking advantage of a guarantor home loan can allow you to get onto the property ladder sooner. This means not only will you have your own property, but it also means you can start paying off the loan, building up equity and possibly making capital gains.
Avoid LMI
Using a relative or close friend as a guarantor when you may not have a sufficient deposit can result in you avoiding LMI expenses if your guarantor is willing to shore up enough equity to satisfy the 20% deposit. LMI is an insurance policy that protects the lender and can add up to thousands or even tens of thousands of dollars. Further, if it's capitalised into the loan, you're paying interest on it.
Increase chances of mortgage approval
Having a guarantor can increase your chances of getting your mortgage application approved, as there is an added layer of security for lenders.
Risks of guarantor home loans
While guarantor home loans can be helpful, they also come with serious risks that both borrowers and guarantors should understand.
Guarantor's property
If the borrower is unable to make their loan repayments due to a change in financial circumstances, the guarantor is then liable to cover the mortgage repayment. If they also can't make the repayments, the guarantor could end up being forced to sell their home to repay your loan.
There also lies the potential to tarnish the guarantor's credit rating if the borrower or the guarantor is unable to meet mortgage repayments.
Equity build could be slower
If you are borrowing 100% of the property's value, this provides less of a buffer if property prices head south. It will also take you longer to build up equity because you have less 'skin in the game'. If you are looking to refinance after a certain period, many lenders also require you to have at least 20% equity or deposit to refinance without paying LMI.
Mortgage repayments could be too high
In the right circumstances, a guarantor mortgage is a useful solution, but if the pledged amount is uncomfortably high and you're unable to meet your monthly repayments, your guarantor could lose their property. If you're borrowing 100-110% of the property's value, the mortgage payments on this will be higher than a traditional 80% LVR home loan.
Family and money might not mix well
Finances and family don't always mix well, so you need to be sure that you'll be able to cope with the situation and work out what to do if things go wrong.
As a home buyer, you'll want to ask the right person, who is financially comfortable and who you feel won't meddle too much in your finances. You don't want there to be tension if you decide to take a holiday, and if they feel that money might be better put towards the mortgage.
Factors to consider if you are considering becoming a guarantor
The main question is: Can you afford it? If your relative suddenly loses their job, can you release equity from your property, or afford to pay the shortfall out of savings or earnings?
Can your relative afford the mortgage? You need to see evidence, rather than going with your feelings because you want them to own their own home. If they haven’t demonstrated discipline and good savings habits in the past, going guarantor could be risky.
Do you have a close enough relationship with the borrower? If you think you might begrudge them going on holiday because you want them to make mortgage overpayments, this could end badly.
Do you understand what you're doing and what your obligations are? Talk to a solicitor even if you think you do.
What can I do if I don't have a guarantor?
Not everyone is fortunate enough to have a guarantor, but your parents and other relatives might be able to help you in other ways, maybe by paying your moving costs or by helping you to decorate your new place.
If you do have to do things alone, then there are still ways to place a foot on the property ladder.
Apply for a low–deposit home loan
Some lenders will let you borrow up to 95% of the property value, however, your LMI premium could potentially balloon to a large sum. You can, however, capitalise your LMI by bundling it into your mortgage so you pay it off as you pay off your mortgage.
Co-buy with your parents or another relative
This means you obtain a home loan with your relative and purchase the property together. While you'll be making the repayments yourself, you and your relative will be equally liable for the repayment of the entire loan. This sort of arrangement can make ownership a bit complicated, so it's important to involve a solicitor to flesh out the finer details.
Increase your savings efforts
It's important that those seeking to jump on the property ladder keep saving and then save some more. Increasing your saving efforts has the potential to save you thousands in both LMI and interest expenses over the duration of your home loan.
To help you achieve your savings goals of home ownership, check out some of the highest rate savings accounts and term deposits available on the market.
Use government shared equity and home buying schemes
Federal and state governments typically have programs designed to give first home buyers a leg-up into the property market. This could include anything from stamp duty concessions, cash grants, and shared equity programs where the government owns a stake in your property and pays some of your deposit.
Other programs, such as the Home Guarantee Scheme allow you to enter the market with as little as 5% deposit without paying LMI.
Guarantor Home Loans vs Home Guarantee Scheme
The federal government’s Home Guarantee Scheme acts as a kind of public guarantor for eligible homebuyers, allowing them to purchase a property with as little as 5% deposit and without paying LMI.
With eligibility recently expanded to a wider range of first-home buyers, many may wonder why you would still go down the path of a traditional guarantor loan backed by mum and dad?
While the government scheme may appear to be the simpler option, Julian Finch, mortgage broker and founder of Finch Financial Services, says there are several reasons borrowers still lean on family members as guarantors.
Finch explained that one key difference is flexibility around the type of property being purchased. While the federal Home Guarantee Scheme (HGS) is limited to owner-occupiers, guarantor loans allow borrowers to buy an investment property
Additionally, the government scheme comes with strict price caps that limit what and where you can buy.
“Around the country, it's a different cap for each state. And then, of course, you've got regional caps as well, which are considerably less than a capital city,” Finch said.
There are also differences in how much flexibility you have with your own savings. Under the Home Guarantee Scheme, borrowers are generally expected to tie up most or all of their savings into the purchase, leaving less room for a financial buffer.
“With mum and dad, of course, you can keep all your cash and put that in offset or leave it as a buffer for maintenance or anything that might pop up unexpectedly,” Finch said.
“Sometimes for the house you want to buy, the type of income doesn't cut the mustard, unfortunately.
“So if you're using mum and dad as a guarantor rather than the government, then you've got a bit more flexibility in the type of income that you earn.”
Finch Financial Services Founder Julian Finch talks about the risks and benefits of guarantor home loans on the Savings Tip Jar podcast.
First published in January 2023
Photo by Kampus Production via Pexels
