What is a guarantor loan and how do you go about arranging one? Here’s a straightforward explainer from the loan experts at TM Finance Group in Melbourne.
One of the biggest challenges on the road to becoming a homeowner, even if you have an above-average income, is saving enough for a deposit.
According to an Australian Financial Review report from August 2020, the average Australian house price is around $800,000. This means you’re looking at a deposit figure of around $160,000, depending on where you want to buy.
Pulling together enough cash for a 20% deposit is difficult, especially for first home buyers.
While it is possible to borrow more than 80% of the value of your new home, a lenders mortgage insurance premium is generally required. When you add on the cost of stamp duty, government charges and solicitor fees, things can start to add up quickly.
Guarantor loans can offer a solution to this. This strategy allows you to purchase a home with a lower deposit required. At a time when interest rates in Australia are low, exploring a guarantor loan as a way to enter the housing market may be a good idea.
What is a guarantor loan?
Your guarantor essentially ‘guarantees’ your home loan by using their own property. That is, the bank holds both your property and your guarantor's property as security for the loan.
Most commonly, it is parents who offer a guarantee so they can help their children buy their first home.
For example, let’s say you wanted to purchase a property for $700k, but only had $35k cash savings. Your parents could guarantee an additional $105k against their property to reduce your lending value to 80% of the purchase price.
What are the benefits of a guarantor loan?
Lower deposit required
Your overall loan is 80% or less so no Lenders Mortgage Insurance is required
Interest rate may be lower as rates with some lenders are tiered for loans above 80%
Some lenders allow you to limit the size of the guarantee
Can I remove the guarantee?
The guarantee on your loan doesn’t have to be permanent. If you can meet the following conditions:
You can afford the repayments without any assistance
Your loan is less than 80% of the property value
You haven’t defaulted or missed any payments in the last six months
You may be able to speak with your bank about removing the guarantee after a couple of years have passed.
Are there risks involved with a guarantor loan?
The guarantor is essentially liable for your home loan if you fail to make your repayments as expected.
If you don’t pay, your guarantor will have to.
While this should not deter you from exploring the guarantor loan to help you make a purchase, it is important both the guarantor and yourself are aware of the potential risks.
Most banks will only allow guarantees from parents, due to the commitment required by the guarantor. However, some lenders also consider guarantees from immediate family such as siblings, grandparents, spouses, de facto partners or adult children.
What if my parents already have a home loan?
For your parents to guarantee your loan while having a mortgage of their own, they need to have enough available equity in the property.
If this is the case, some lenders will consider a second mortgage for the purposes of the guarantee.
If you are not sure how much equity is in your parents’ home or how this is calculated, one of the TM Finance staff would be happy to run through this process.
Consult an expert
Becoming a guarantor on someone else’s loan is a large commitment. Seek the advice of financial professionals such as brokers, solicitors and financial advisors before you decide to proceed.
Preliminary discussions with a solicitor are recommended before applying for a guarantor loan, and aiding your understanding in legal documents such as ‘Guarantee and Indemnity’ forms.
Here are some of the things you need to be aware of when applying for this style of mortgage and some reasons why it makes sense to talk to TM Finance Group:
Getting approval: Lenders are particularly conservative with guarantor loans. Our loan advisers know which lenders accept which types of guarantees.
Know the terms and conditions: Some banks have simple terms and conditions for their guarantor loans and allow you to limit the amount of the guarantee. Many lenders will not limit the guarantee but this places the guarantor at higher risk if you cannot make your repayments.
The exit strategy: The loan may have a term of 30 years; however, you don’t need to keep the guarantee in place for that long. TM Finance Group can help you work out a strategy of either making extra repayments or refinancing to remove the guarantee in as little as two to five years.
Protecting the guarantor: If you cannot pay your loan, how can you protect your guarantor from having to pay for you, and possibly losing their home? Did you know that you can reduce the risk to the guarantor by obtaining insurance? Let’s talk to you can be clear on your options.
If you don’t set up your mortgage in the right way, you may be putting your guarantor at a higher risk, or you may not be able to remove the guarantee as quickly as you would like.
Do you have questions that were not answered above? Chat to us today, and allow us to help kick-start your financial goals!
Read more: Don’t risk it, get a lawyer