Having a family member who owns property to act as your guarantor means you can get a mortgage more easily. You don't need to save 20% of the property's price and you can avoid a hefty lenders mortgage insurance premium. But there are risks you need to know about.
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How does a guarantor home loan work?
If you have a close family member with equity in their property (that means, they own all or most of the property) they can guarantee your deposit. You still need to borrow money from a lender and repay it, but the guarantor provides security.
And that's the catch: if you are unable to repay the mortgage your guarantor may have to.
To minimise risks a guarantor can guarantee only a portion of a loan, say, 20%. Once the borrower has repaid 20% of the loan the guarantor's property is safe even if the borrower fails to repay the remaining 80%.
Let's examine the process with a typical guarantor scenario:
Guarantor mortgage scenario
- John and Rachel purchase a $600,000 apartment with a 5% deposit ($30,000).
- They estimate their lenders mortgage insurance (LMI) premium using Genworth's calculator and are shocked to learn they'll need to pay $25,000.
- Rachel's parents own their home outright. They agree to guarantee a further 15% ($90,000) of the property cost. This eliminates the LMI cost completely.
- John and Rachel repay $150,000 of their loan over the next few years. Rachel's parents are no longer liable because the $90,000 they guaranteed has been repaid.
Who can act as a guarantor?
Some lenders only accept parents as guarantors while others accept close relatives. Every lender has different requirements, but the following criteria usually apply:
- Finances and credit. A guarantor needs equity in their property, a stable income and a good credit rating to satisfy lenders.
- Residency. Lenders generally want a guarantor to be an Australian citizen or permanent resident.
- Age. A guarantor must be over 18 and typically under 65.
How much can I borrow with a guarantor?
With a guarantor, many lenders will let you borrow up to 100% of the value of a property or even up to 110%.
Even if you have a 5% deposit saved a guarantor can be beneficial. Having your parents guarantee a further 15% of the deposit means you can avoid paying LMI.
Note that some lenders require borrowers to have at least 5% of a deposit in genuine savings, even with a guarantor.
Risks and benefits of a guarantor mortgage
For the right borrower having a guarantor is a huge help. But if you cannot make a mortgage repayment your guarantor's property might ultimately become the bank's property.
- Get into the property market faster. Once you're in the market and paying off your loan you can build up equity and enjoy capital gains if the property grows in value. If you spend more time saving up a 20% deposit without a guarantor the property might grow in value and you'd need to save even more.
- Avoid LMI. Lenders mortgage insurance can add thousands of dollars to your home loan. A guarantor loan takes this cost out of the equation.
- Improve your chance of getting approved. Having a guarantor will strengthen your home loan application.
- Your property at risk. The guarantor risks their property if the borrower can't repay their loan. It's a serious risk and both borrower and guarantor need to understand it fully before entering a guarantor arrangement.
- Relationship strain. Mixing family and financial relationships can cause serious emotional strain. You should evaluate not only your finances but your relationship beforehand.
Planning to act as guarantor for your child? Ask these questions first
- Can I afford to go guarantor? Assess your financial situation realistically. Plan out a scenario where you suddenly become liable for the full amount you've guaranteed.
- Can the borrower afford this loan? Try to assess the borrower's financial situation as clearly as possible. Don't make this judgement on instinct either: ask for hard evidence.
- How is your relationship with the borrower? Just because you're close family doesn't mean you get along at the best of times. And with large sums of money involved even good relationships can become strained.
- Have I sought professional advice? Get independent legal advice to make sure you fully understand the guarantor process.
What are my options if I can't get a guarantor?
Having a parent who is able to guarantee your deposit is a privilege that many borrowers don't have. Your parents may be able to help in other ways or you may have to go it alone. Here are some options:
- Get a low deposit home loan. Low deposit home loans let you borrow up to 95% but LMI can be very expensive. You can capitalise LMI costs, meaning you fold the premiums into your mortgage and repay both together.
- Co-buying. A co-borrowing arrangement means getting a loan with your parents and buying a property together. You and your parents will both be liable to repay the entire loan. Ownership arrangements can also be complicated.
- Rentvest. If you can't afford a home where you want to live, you could buy a cheaper property somewhere else and rent it out. You're building wealth through an affordable investment while living somewhere else.
- Keep on saving. You can also just keep scraping a bigger deposit together. Here are some strategies to help you build your deposit.
A mortgage broker can help you navigate your options as a borrower, whether you need a guarantor or not.
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