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Frequently asked questions about using a guarantor

August 23, 2019

There has never been a better time to get into the housing market, and we’re seeing more and more parents decide to help their children out so they can get into the market while interest rates are at record lows. New studies out show that almost 40% of first home buyers rely on family assistance—either a cash gift or parents going guarantor.

Not all parents have the cash on hand to help fund a deposit, so others choose to go guarantor. It’s important that both the buyer and their guarantor understand what’s at stake before you commit to the decision. This fact sheet, with information provided by our friends at Clarity Home Loans, covers the most commonly asked questions, including what other options are available to you.

What is a guarantor?

A guarantor is someone who provides a guarantee to the lender on behalf of a third party: usually an adult child or close family member. The guarantee works by using all or part of the equity in the guarantor’s own property as security for the loan.

This allows the borrower to borrow up to the entire cost of the property - up to 105% in order to cover purchasing costs - without a deposit.  It can also be useful for borrowers who do have a deposit, but less than the 20% required to avoid Lenders Mortgage Insurance. As the guarantor property provides security for the lender, LMI is not required.

How long does a guarantor arrangement last?

A standard period for a guarantor arrangement is five years, but this can change depending on circumstances.

Once the property is purchased, it begins accumulating equity. Once the equity reaches 20%, the primary borrower can refinance the loan and release the guarantor. If the guarantor wants to be released earlier, this is also possible, although it will require the borrower to take out an LMI premium relative to the current loan to value ratio (LVR).

Who can be a guarantor?

The most common scenario is that the parent/s of the primary borrower become guarantor/s. However, some lenders use a more liberal definition of the term ‘guarantor’ than others and allow siblings, ex-spouses or even friends to go guarantor. Most lenders also require the guarantor to prove that they are still in employment or can service the debt another way.

If you’re considering using a guarantor, talk to a broker early on in the process to get advice on which lenders might be suitable.

What are the risks for a guarantor?

In the vast majority of cases, nothing will go wrong. But before you make the decision, here are the possible risks to the person who chooses to go guarantor.

Inability to move

  • Because their property is acting as the bank’s security for the loan, the bank lodges an interest against it. This prevents them from selling it without their permission.

Possibility of losing their home

  • If the borrower fails to meet repayments, the bank has the right to sell the guarantor’s property to make up the shortfall.
How can you reduce the risk?

If you do decide to go down the guarantor path, there are two strategies we recommend to mitigate the risk.

Stick to principal-and-interest loans.

  • Focus should be on building equity fast. Once you get to an 80% loan to value ratio (LVR), you can refinance. The bank will then release the guarantee.
  • Some lenders will also allow you to refinance once you have an LVR under 95%, although you will still need to take out LMI.
  • Paying down principal as well as interest helps you build equity faster.

Take out income protection insurance

  • 85% of all property foreclosures happen because a borrower becomes sick or injured and can’t work.
  • Income protection through your superannuation is usually limited to catastrophic injuries or death.
  • A policy in your own name that will cover you for periods where you are unable to work means that you can meet your loan obligations even if you get sick or injured, and your guarantor will be protected.

Get independent legal advice

  • It is Clarity Home Loan’s policy to hold a private conversation with the would-be guarantor to make sure that they understand the undertaking and do not feel pressured.
  • We strongly suggest that they get independent legal advice.
What other ways can a family member help you buy a home?

Perhaps you or your would-be guarantor have decided not to enter into a guarantee after all, but they still want to help. Here are some ways they can do so:

Cash deposit

  • This is a much lower risk option for your parents.
  • A loan against the equity in the parent’s property can be arranged if they’re still working.
  • Retired parents can take out a reverse mortgage. These are more expensive and complex, so should be considered a last resort.

The deposit does need to be a non-refundable gift for the bank to accept it. However, there’s nothing to stop you paying it back down the track.

Letting you live at home

  • If your living expenses are low, it’s easier to save for a deposit on your own.
  • Living with your parents can dramatically decrease your overheads and get the deposit together faster.

If you’re thinking of buying a home using a guarantor, or you want to know what other options are available, we strongly suggest seeing a mortgage broker, who can give you the necessary advice and help you find a lender that fits your needs best.