A guarantor home loan is a type of mortgage that allows a borrower to have a family member’s property act as additional security for the loan. The lender uses the guarantor’s property as collateral for the loan.
Guarantor home loans are becoming increasingly popular in Australia. However, before you decide if this is a good choice for you, it’s important to understand what’s involved and how you can get out (if needed).
A guarantor can typically be released from a home loan when the borrower has paid down a significant portion of the loan or once they’ve built up enough equity in the property (at least 10% or 20%) to avoid paying lenders mortgage insurance (LMI).
If you’re considering a guarantor home loan, we’ll go over how a guarantor home loan works, how to remove a guarantor, and when it’s the best time to do so.
How A Guarantor Home Loan Works To Avoid Lenders Mortgage Insurance
A guarantor home loan is designed to help first-time home buyers who may not have a large enough deposit to qualify for a traditional mortgage, or who are looking to avoid paying lenders mortgage insurance. In most cases, a lender requires a borrower to pay LMI when they don’t have a sufficient deposit, which can be a significant additional expense.Â
In the case of a guarantor loan, the lender generally waives the requirement for LMI if the guarantor’s property is used as additional collateral for the loan. This makes it a viable alternative to coming up with a larger deposit, which can often make the difference in securing a property.
Here’s an example of how a guarantor home loan works
Lucy has her eye on a home worth $500,000 and has worked hard to save a deposit of $50,000 (10% of the property value).Â
Since she doesn’t meet the 20% requirement, Lucy has to pay LMI. She doesn’t want to pay this extra fee but worries someone else will buy her dream home. Fortunately, a guarantor loan can offer her a quick solution.
Her father offers to guarantee her home loan using $50,000 of his home’s equity. This way, Lucy has the 20% needed to avoid LMI costs and she is in a position to make an offer.
It’s important to note that being a guarantor is a serious commitment, and it can put the guarantor’s assets at risk if the borrower can’t repay the loan. If Lucy defaults on her loan repayments, as the guarantor, her father would be liable.
Therefore, both the borrower and guarantor must be fully aware of the terms and requirements of the loan and the risks involved before entering into this type of agreement.
How To Remove A Guarantor From Your Loan
It’s not always necessary to have your guarantor as security for the whole duration of the loan period. The idea of a guarantor loan is to help you with the push you need to get into the property market. Once you’ve paid off some of the loan, you might find that the lender no longer needs the additional security.Â
Key factors for removing a guarantor from your loan
Generally, guarantors stay on a mortgage for two to five years, but the length of time will depend on a couple of factors:Â
- How quickly you pay down the loan. The faster you can pay off the loan, the sooner you’ll be able to remove the guarantee.
- How fast your property increases in value. If your property value increases rapidly, you can refinance and remove the guarantee sooner.
It’s important to note the guarantee is not automatically removed by the lender.Â
Criteria for releasing the guarantee
Your loan-to-value ratio (LVR) should be at least 80% to demonstrate that there’s sufficient equity in the property, which will act as collateral in case you cannot make your mortgage payments.
However, it’s important to remember two considerations:
- Once you remove the guarantor, their property no longer serves as collateral, and the lender will need to have some other form of security for the loan.
- The guarantor’s security can be removed at above 80% LVR, but lenders mortgage insurance will be required in most cases.Â
While most lenders have similar policies, the criteria may slightly differ depending on the mortgage provider. At The Mortgage Agency, we focus on getting the right outcome for you, based on your unique circumstances. Contact us if you have questions or would like to learn more.
The Best Time To Release Your Guarantor
The optimal time to release the guarantor is once you’ve paid off 20% or more of the loan amount, when your LVR is sitting at 80%. However, some lenders will consider an LVR of 90% if you pay LMI.
Before getting family members involved as guarantors, it’s beneficial to clarify expectations. For example, ideally you’d like to have them secure your loan until you’ve paid off more than 20% of your loan.Â
Key Takeaways
If you have a relative who has agreed to be the guarantor for your mortgage, it’s essential you both understand what’s required and set a clear, realistic timeframe for how long the guarantor will stay on the mortgage.Â
- The goal should be to release the guarantor when your loan-to-value ratio (LVR) is at 80%. At this point, you can apply to refinance.
- If you are able to make additional payments to your mortgage and pay it off more quickly, you can release your guarantor early.
- It’s important to remember the guarantor is not automatically removed at a certain point during the life of the loan.
Finding The Right Mortgage Broker
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