The main issue for many first-time homeowners and investors in the current property market is the ability to save a deposit.
With rapidly rising house prices, pulling together a deposit remains a struggle for many would-be property buyers, especially when most still have to pay ongoing standard living expenses, such as rent, utilities and groceries.
However, with interest rates at historic lows, it is important to understand that the ability to afford mortgage repayments once you’re in the market has improved significantly. So, it’s worth pushing on, even though it’s difficult!
One way to get a start on the property ladder sooner is by using guarantor home loans that can help get more prospective buyers into their first property. Understanding the guarantor home loan requirements will help you decide if this is an option worth pursuing.
Guarantor Loan Requirements
What is the structure of guarantor home loan?
Guarantor loans can be a great way for young people to achieve a deposit, but their ins and outs must be understood from the outset.
- A guarantor home loan is when someone else provides equity or security from their own property to fund part, or the whole, deposit of another person’s property.
- A simple way to define guarantor is a person or persons who assumes responsibility for paying off the loan if you’re no longer able to meet your financial commitment. Essentially, the guarantor takes financial responsibility for servicing the home loan in the event that you default on your repayments. Even if the guarantee is only for 20 per cent of the entire loan, the guarantor will be wholly and severally responsible for the entire loan but doesn’t have ownership rights to the property.
- A guarantor loan requirement is that there is sufficient equity in the property being offered as security (that is, sufficient equity in the guarantor’s own property).
- A guarantor doesn’t need to be involved in the loan for the entire duration of the loan. Instead, it’s advisable that the property owner actually works towards getting the guarantor released from the loan, by increasing equity, which can be achieved by paying down the mortgage or improving the property via renovations and therefore increasing its value.
The most common types of guarantee are:
Servicing Guarantee – Where the guarantor supports the borrower’s loan facility with their income, and;
Security Guarantee – Where the guarantor offers additional security, such as part of the equity in the family home, to provide adequate security to the lender for their loan requirements.
A security guarantee is the most common and often used to help lower the loan-to-value ratio (LVR) below an 80 per cent threshold thus allowing the borrower to avoid paying lender’s mortgage insurance (LMI).
The upside of the facility is that the guarantor doesn’t need to physically hand over any funds to the lender at the time of the approval. Instead, they simply assure the lender they will cover the shortfall if the borrower defaults.
Of course, for the facility to work, the guarantor must have sufficient equity in assets offered as security.
An example of how a guarantor loan can work is:
John and Jill want to buy a $750,000 home but have struggled to save a big enough deposit. In fact, they have only managed to save enough to pay the stamp duty and associated costs. As newly-weds, they approach John’s parents who have paid off their own home, who then agree to use $150,000 of their own equity to finance the required 20 per cent deposit for the couple.
Who can be a guarantor?
Meeting the guarantor home loan requirements is a matter of understanding who can provide guarantor capability. The main consideration with guarantor home loans is that they must be provided by someone who has a strong relationship with the buyer or buyers, which generally means immediate family members such as:
- De facto partners.
It’s not the case that just anyone can act as a guarantor.
One of the guarantor home loan requirements is that the rules stipulate there must be a link between the guarantor and the guarantee, and there must also be a financial benefit for the party offering the guarantee.
Family guarantors are common because of the obvious familial link. Among the usual parties acting as guarantor are parents, siblings, grandparents, spouses and de factor partners.
The financial benefit to family members is that they don’t need to dispose of their own asset in order to assist their relative (for example, their child). Instead, the guarantee means they can put up equity while still retaining ownership and control of that asset.
Another way to look at it is that it’s a way for a parent to pay forward some future inheritance without penalising them financially in the present.
Another guarantor/guarantee relationship is one around legal entities such as a companies or trusts. In this case, the entity itself may not have sufficient assets to qualify for a loan, however those linked to the trust or company do. In this situation, a company director or trustee guarantees the legal entity’s loan arrangement.
There are a number of considerations for guarantor home loan requirements that the lender will take into account. These include:
- Their age
- Whether their property is in Australia
- If they have sufficient equity
- Whether they are currently employed
A guarantor also needs to be of sound mind and will need to seek both legal and financial advice before making the decision to act as a mortgage guarantor.
Before asking a relative to go guarantor you may also want to consider how long does a guarantor stay on the mortgage? Being able to plan and budget mortgage repayments to give an indication of when they will be released may also support your request to a potential guarantor.
Also, being able to answer their questions, such as, ‘how does a guarantor work?’, or ‘how long does a guarantor stay on the mortgage?’, may also support your request and help potential guarantors understand the risks.
How much can you borrow?
While the lending environment remains tight, there are more loan products on the market now that suit first home buyers.
These are generally loans that offer higher loan-to-value ratios (LVR), which ultimately means that the deposit can be lower.
For example, there are loans which require only a five to 10 per cent deposit, which makes it easier to save the required amount.
On top of that, many first-timers might then use a guarantor to increase the deposit to 20 per cent of the purchase price which will remove the requirement to pay Lenders Mortgage Insurance or LMI.
In fact, by using a guarantor home loan, lenders are generally more flexible with their lending criteria, which means that prospective property buyers can usually access loans with LVRs in the 90 per cent range.
Of course, guarantor home loans do require a number of checks and balances, such as a requirement that you hold documentation for three days. This will mean you have been deemed to have read and understood the requirements.
How does a guarantor work?
When considering a guarantor mortgage, both the borrower and the potential guarantor need to understand the risks involved in order to make an informed decision.
A guarantor must have a good credit score, have equity in the property to used as security and a stable income. In other words, the bank must deem the guarantor a safe risk when assessing the borrower’s application.
Choosing a someone to go guarantor for you when you are applying for a guarantor mortgage can be difficult because the options are quite limited. Generally, the banks will only accept a close relative, and usually only an immediate family member, as a guarantor. This means it’s likely only a parent or sibling, often (but not always) a grandparent can be accepted. Distant cousins who live overseas are unlikely to be an acceptable guarantor prospect for most lenders.
The risks of going guarantor
The primary risk of going guarantor is if the borrower defaults on the loan arrangement, you are legally required to make repayments, or cover the outstanding loan amount. This means the lender may choose to foreclose on that guarantee asset and sell it in order to recoup their losses.
The best way to mitigate this risk is simply through due diligence. Even when going in to bat for your own kids, do a level-headed assessment of their ability to continue meeting their requirements before choosing to risk your own financial security.
Another consideration is that if you are guarantor on a loan facility, this encumbrance will be factored in as part of any loan application you make for yourself. Whether it be a servicing or security guarantee, your own lender will be assessing the effect of that commitment and its potential risk as part of their processes.
It’s wise to get your own advice to understand all the guarantor home loan requirements before being party to a guarantor home loan for your children or other relative.
How long does a guarantor stay on a mortgage?
A guarantor doesn’t need to be involved in the loan for its entirety. Instead, it’s advisable that the property owner actually works towards getting the guarantor released from the loan.
Releasing a guarantor is not a difficult process, and often occurs when one of two things happen:
- Increasing equity in the principal property: Say, the guarantor home loan was used to help a family member avoid LMI by introducing security that lowered the LVR to 80 per cent or less. If, after a year or two, the value of the home increased and/or the outstanding balance of the loan decreased to the point that the LVR fell below the 80 per cent threshold, regardless of the guarantee security, then the guarantee can be released.
- Refinance: If the prime borrower refinances the property with a new lender who does not require the guarantee, the security can be released as part of the normal refinancing process. Keep this in mind too – the borrower’s financial situation will probably change over the coming years. They may receive a pay rise or build another asset base. Multiple events can occur which eventually render the guarantee unnecessary, and arrangement can be made at any time to release the beholding party.
How to find and compare guarantor home loans
The home loan market is broad and diverse, and most lenders offer the guarantee facility or some kind of guarantor mortgage product across most, if not all, of their product range.
Also, with a guarantor home loan, having a guarantor doesn’t affect the basic terms of a loan, such as the interest rate. It’s more about assisting the outcome of the loan application.
That means your primary goal is to first choose a loan facility that provides the best terms and conditions for your particular situation. Once you’ve unearthed your ideal loan, it’s a matter of discussing the use of the guarantee as part of the application process.
But selecting the right loan for you can be challenging without the assistance of an experienced mortgage broker.
The world of banking can be a pretty daunting one for both novice and sophisticated investors, and since our establishment in 2002 we’ve focused on providing outstanding service and business standards.
This approach was vindicated when we were named Victoria’s favourite mortgage broker at the Investors Choice Awards.
So, if you’re considering buying a property, why not contact Intuitive Finance today to ensure you have the right information and expert support on your side from the very beginning.
Discuss your specific needs and formulate the right strategy for you. Get in touch to organise your complimentary 60-minute session today!
The information provided in this article is general in nature and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information with regard to your objectives, financial situation and needs.