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 be up to as high as $27,000 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% inclusive of LMI’ and in some case to just ‘90% inclusive of LMI’ 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
- All the guarantor to nominate a specific amount that their guarantee is limited to rather than guarantee the entire loan amount
- Reduce or avoid Lender’s Mortgage Insurance (LMI) because your parents will put up additional security via a limited guarantee amount secured against their property, enough to bring your ‘loan to value ratio’ (LVR) down to at least 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, the guarantor can ask to be released from the guarantee (provided the borrower is not in default), 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 inclusive of LMI’ 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 $500,000 to purchase a property also valued at $500,000 (as he only has enough deposit to be able to cover the Government’s stamp duty, bank application fee and Conveyancing costs). The LVR for this example is 100%, which is outside of acceptable ‘loan to value ratio’ caps 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 limited guarantee amount required by the guarantor to help Mr Avoid LMI would be for $125,000. In this instance, $500,000 / $625,000 = 80%.
If the guarantor decides to put up a limited guarantee amount of less than $125,000, this would simply mean LMI is still required but at a significant discounted amount. Mr A’s home loan repayments will still be based on a $500,000 home loan amount.
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. The guarantor is liable for the amount specified in the limited guarantee.
- The guarantor must be interviewed by us separately without the borrower present.
- Guarantor packs (after the borrower’s loan has been formally approved) will be posted by the Bank directly to the Guarantor and must be returned directly by the Guarantor to the Bank.
- 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. We say this because 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 also recommend the guarantor sit down with their Financial Planner to understand how becoming a guarantor may impact on their own financial situation now and while acting as guarantor. It’s important the Guarantor does this 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, adult children, and a spousal 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.
- Any legal action taken under the guarantee will be in terms of section 28.14 of the Code of Banking Practice which states: “The Bank will not, under a guarantee, enforce a judgement against you unless:
- 1. The have obtained judgement against the borrower for payment of the guaranteed liability which has been unsatisfied for 30 days after they have made written demand for payment of the judgement debt; or
- They have made reasonable attempts to locate the borrower without success; or
- The borrower is insolvent