A guarantor loan is most commonly used by first home buyers to enable them to enter the property market by utilising their parents as a guarantor (for security purposes only) which will also enable them to avoid the high lender’s mortgage insurance (LMI) premium which can range from $5,000 to $20,000 depending on the purchase price and loan size.
Some parents today are thinking about how they can help their children break into the property market, without having to dip into their own savings or liquidating their own assets. The ability to borrow up to 100% (and sometimes up to 110%) is the big attraction of guarantor loans. Guarantor loans are now the only product that allows a borrower with no deposit or little deposit to buy a home and as a result, their popularity has increased. This popularity increase is also as a result of the major banks reducing their maximum LVR’s to 95% and in some case to just 90% and tightening their credit criteria.
Benefits of a guarantor loan
- Purchase the property you want rather than having to settle for a cheaper alternative
- Still be entitled to normal interest rates and the normal suite of home loan products
- Avoid Lender’s Mortgage Insurance (LMI) because your parents will put up a limited guarantee amount enough to bring your ‘loan to value ratio’ (LVR) down to 80%
- Your parents won’t need to hand over cash to you, nor will they need to make repayments on their limited guarantee amount while they’re acting as guarantor
- Any time after settlement, your parents can discharge their responsibility as a guarantor, however, if in your own right your LVR is above 80% then you will have to pay the required mortgage insurance premium at the date of discharge
- The earliest your parents can discharge their responsibility is when you can achieve a 95% LVR in your own right (i.e. your loan balance divided by the valuation of your property).
Example of a guarantor providing security support only:
Mr A is seeking to borrow $392,000 to purchase a property valued at $400,000 (as he only has enough deposit to be able to cover the stamp duty and other expenses associated with buying a property and $8,000 of initial equity). The LVR for this example is 98%, which is outside of acceptable security limits for any bank. In order to help Mr A obtain his loan, Mr A’s parents have agreed to allow the Bank to take a mortgage over their property in order to provide a limited guarantee. The amount for loan 1 will be the ‘purchase price * 80%’ and the amount for loan 2 will be the ‘remaining loan sought amount’ which will also be the limited guarantee amount.
So, loan 1 will be $320,000 and loan 2 will be for $72,000; i.e. the limited guarantee amount. NB: a limited guarantee only reduces the LVR so as to avoid LMI, and does not reduce the loan amount requested from Mr A. Mr A’s repayments will still be based on a $392,000 home loan amount.
What we would like to know upfront is which bank your parents mortgage is with, how much is left owing, roughly the value of their property and how much they earn per year. That way, we we can then determine your best lender and product options going forward.
Things you need to know upfront about a guarantor loan
- With guarantees, if down the track you default on your home loan, the Bank can then demand repayments be made from your parents until you get back up on your feet again.
- If your parents own their home outright, then the Bank will want to take possession of their title and will only return it once your parents discharges their responsibility as guarantor.
- Your parents may only have to act as guarantor for less than a few years. As the value of your home increases and you pay down your loan, your parents should be able to withdraw their support. This frees up your parents to consider other options for the use of their property’s equity – such as for their own investment plans. Your parents can remove the guarantee once you owe less than 95% of the property value & if you meet the LMI and bank lending criteria at the time. However, it is better to remove the guarantee when the loan has been paid down to 80% of the property value, as this will avoid the need for you to pay LMI.
- Offering a guarantee may limit your parents future borrowing potential.
- As long as your parents combined limited guarantee amount and their existing mortgage amount is less than 80% on their own property’s value then a guarantor option is still a viable option.
- Most lenders require guarantors to seek legal advice prior to settlement of the loan. We recommend your parents to sit down with a lawyer before you buy your home, only because if they decide to be guarantor initially and then decide not to proceed after formal approval, then you may be left unable to complete the purchase.
- All lenders allow immediate family to be a guarantor, apart from your parents this can include an aunt, uncle, grandparents, and a defacto partner.
An alternative to guarantor loans is for your parents to give you a gift as a deposit. In most cases a gift of 10% of the purchase price is enough to allow you to qualify for a loan on your own. This option is suitable for parents who are in a strong financial position or who are not comfortable providing a guarantee secured by a property that they own. Bear in mind though, the gifted funds have to be in your own account for at least 3 months prior to buying your home.