Saving a substantial deposit for a home loan can take years, and for those with limited income, it might seem like an impossible task. Fortunately, there are other options that can help get people into their own homes when in a difficult financial situation, such as through a guarantor loan.
If they don’t meet the income requirements or have enough of a deposit, a guarantor home loan is a common option for home buyers looking to borrow money from a lender when having difficulties gaining approval.
What is a Guarantor?
A guarantor is a person who acts as a third party alongside the borrower and fronts additional security for a loan using their own assets to allow the borrower a better chance of receiving approval.
The guarantor is usually a family member with sufficient equity to put forward. Guarantors must be both over 18 years old and have a good credit history.
Guarantor loans differ from typical home loans in a few key ways, mainly regarding the security required. Before a lender can give a sum of money to a borrower, they first want to ensure there’s a tangible and well-valued asset that can act as security against the loan.
In a typical home loan, the security guarantee is the property itself. If loan repayments default, the bank or lending institution can reclaim the property. In a guarantor loan, the security put up by the guarantor will be reclaimed instead (usually a piece of the guarantor’s property or a sum of money).
This allows a bank to have more confidence in lending if the borrower defaults on loan repayments, and also enables home buyers to get into the property market sooner.
However, it’s also a potentially risky situation, particularly for the guarantor, as they’ll be required to pay back the entire loan if the borrower defaults.
Who Might Need Guarantor Home Loans?
There are many reasons why someone might need support from a guarantor, but here are some common examples:
- Young adults: If you’re just starting out in your career, you may not have a decent credit history or high level of savings that would encourage a bank to provide a home loan.
- People with poor credit: If you have a low credit score, you may need help getting approved for a loan. In that situation, a guarantor home loan can help you get the necessary funds, this is because you may not be system declined when you have a guarantor and the LVR is below 80% when your credit score is low
- Your borrowing power is good, however you are limited from what you can buy due to having minimal deposit.
Guarantor home loans can also help you avoid potentially having to pay Lenders Mortgage Insurance (LMI) – provided that between you and the guarantor, you have more than 20% of the deposit needed for the property’s purchase price.
How to Get a Guarantor Home Loan
First, you’ll need to find a lender with an Australian credit licence who offers this type of loan. Luckily, many banks, credit unions, and other financial institutions provide them. Do your due diligence and research to find the best option that suits you and your situation.
Once you choose your lender, you’ll need to provide basic information about your financial position, including your income and expenses, as well as information about the guarantor.
Lenders usually have solid requirements for those whom they’ll accept as guarantors. Any potential guarantor must have a strong relationship with the person they’re acting for, which is why immediate family members are a common choice.
- Parents and step-parents
- Adult children
- De facto partners
What Risks Are Involved?
Whether you’re planning on becoming a guarantor or enlisting someone to act as a guarantor on your behalf, you should be aware of the potential risks involved for both sides.
Getting a Guarantor Can Cause Rifts
It may seem like there aren’t many cons about having a guarantor to support you through getting a home loan, but if you default on the loan and effectively force the guarantor to start making payments on your behalf, you could strain the relationship and cause potentially long-lasting issues.
It’s essential to be confident in your ability to service the mortgage and in your relationship with the guarantor, to ensure it can last the duration of the loan.
Becoming a Guarantor Can Cause Financial Issues
Acting as a guarantor for a family member or close friend is generous, but not without risk.
The key risks involved are:
A negative mark against your credit report
If the borrower whom you’re guarantor for fails to pay the home loan repayments and you’re unable to as well, you risk a negative mark on your credit report.
Struggling to get a future loan
If the mortgage repayments default, you will likely find it challenging to get another home loan. Even if things are going well, you must still declare your guarantor status to the lender. This may impact their decision to lend to you or not.
Paying back the entire loan amount
You carry the debt repayment if the borrower isn’t able to, which makes you liable for either fronting up the debt amount or losing the asset you put up for security.
A guarantor home loan can be a useful option for people who cannot get approved for a traditional loan, and would prefer not to pay lenders mortgage insurance.
If you’re considering getting support from a guarantor, ensure you understand the responsibilities of both the borrower and the guarantor before signing any contracts.
With the right lender and a responsible, trustworthy guarantor, a guarantor loan can help you get the funds you need to get into a property sooner.
Our brokers at The Mortgage Agency can provide expert advice and guidance if you’re considering whether this particular loan is right for you or not. Contact one of our mortgage brokers today to learn more.