Short on a house deposit? Here’s how to get a guarantor
- A guarantor is somebody who offers their home equity as security to help you secure a home loan. Parental guarantors are the most common type of guarantor.
- Potential borrowers often use a guarantor to avoid Lender’s Mortgage Insurance (LMI), a pricey insurance policy that protects the lender if the borrower defaults. LMI is usually required with a deposit of less than 20% of the property’s value.
- Guarantors can usually be released from the guarantee when equity in the purchased property reaches 20%. You must apply to the lender before a guarantor can be released from the contract.
What is a Guarantor?
A guarantor is somebody who helps you strengthen your home loan application by using the equity on their property as security. Guarantors are not the same as co-signers or co-applicants, because they are not listed as a property owner. As the applicant, you will still have to prove that you are able to pay the mortgage on your own. However, if you default on your payments, the guarantor will be responsible for paying the loan up to the guarantee amount.
Why Do I Need a Guarantor?
Guarantors are often used to help a potential borrower avoid pricey Lender’s Mortgage Insurance (LMI). If you have a deposit of less than 20%, then you are typically required to purchase LMI.
LMI is an insurance policy that protects your lender if you are unable to make your payments, and it can cost thousands of dollars. The cost is based on individual risk factors. It can be affected by your job and the amount of your loan and deposit.
Many borrowers, especially first home buyers, find that saving for a deposit is a moving target. As you save, house prices are going up, meaning that the amount you need for a 20% deposit goes up too. To avoid paying LMI, many borrowers decide to enlist a guarantor.
Who Can Be My Guarantor?
Banks usually require that a guarantor be a parent, though occasionally lenders will extend the definition to include spouses, siblings, or grandparents. Acting as someone’s guarantor can come with risks, so it’s important that a borrower and a guarantor have a close relationship.
Specific requirements vary between lenders, but banks typically ask that the guarantor owe less than 80% of their property’s value or own it free and clear. In some cases, lenders may not approve a guarantor who is retired or close to retiring, and the property must be in Australia. Guarantors should not be planning to sell their property in the near future, as that can create complications with the home loan.
How Does Having a Guarantor Work?
Your guarantor does not guarantee the full amount of your home loan; only a limited amount. For example, say you want to take out a loan of $400,000 but only have a 15% deposit of $60,000. All you need is an additional $20,000 and you’ll meet the minimum 20% deposit, avoiding LMI.
Your parents can guarantee that 5% using the equity in their property. If you default on your loan payments, the lender may require you to repay the amount you have guaranteed. While they are guarantors, the lender will hold the Certificate of Title for their property.
When Does the Guarantee End?
The guarantor’s loan can be set up as part of a split home loan, which can make it easier to manage. A guarantor does not need to wait for the entire home loan to be paid in full, though there must be 80% or less remaining on the loan. Otherwise you could still be liable for LMI.
A guarantor is released from the home loan when the guaranteed loan is paid off or if the property increases in value by the amount of the guarantee. When a guarantor is eligible to be released from the home loan, you must apply to your lender. Your guarantor will not be automatically released from the loan until you have done so. When the application is successful, the Certificate of Title is returned to the guarantor.
Are There Risks to Using a Guarantor?
Using a guarantor is not without risk, both for the borrower and the guarantor. It is a legally binding agreement that can affect the finances and the relationship of both parties should something not go to plan. Risks include
- The guarantor can be held liable if the borrower defaults on the loan, meaning the guarantor may have to come up with the money out of savings or by taking out a second mortgage or personal loan.
- A loan default can affect the borrower’s and guarantor’s credit.
- The guarantee can affect the guarantor’s borrowing capacity for separate loans.
- The lender is legally permitted to sell the guarantor’s property to recover the guaranteed funds, though this is a worst-case scenario.
Alternatives to a Guarantor
Getting a guarantor for a home loan isn’t the right choice for everyone. Entering into such an agreement is a big decision, and it may be too risky for some. If you’re keen to enter the property market but don’t have a large enough deposit, there are other options to consider; however, they do still involve depending on others.
- Take out a loan with a trusted family member or friend. This is a big commitment for both of you as you’ll both be co-owners of the property. On the other hand, you can both benefit if the property increases in value.
- Ask for help with your deposit. A family member may be able to contribute some funds that can get you over the line to a 20% deposit.
- Keep on saving. It’s not always possible, but first home buyers often save on rent by moving in with their parents for a limited period of time, or by putting in overtime at their jobs.