If you feel like homeownership has become more unattainable as each year goes by, you're not alone. House prices and minimum deposits have been steadily rising for several years, while incomes have not kept pace.
In fact, according to ABC data, almost 2 out of 3 Australians don't think home ownership is an option for young adults anymore. It's no wonder more home buyers are looking for alternatives to a traditional home loan to enter the property market.
One of the most popular options is a guarantor home loan. However, it's not for everyone and you need to be aware of some of the disadvantages too!
Keep reading to discover all about guarantor home loans and if it's the best pathway to homeownership for you.
What is a guarantor home loan?
Traditional home loans usually require borrowers to provide a 20% house deposit. If your deposit is lower than that amount, you would have to pay lenders mortgage insurance (LMI).
To avoid LMI, many opt for a guarantor home loan. In this arrangement, a family member pledges some of their own home equity to the lender and combines that with your smaller deposit to make up the 20% deposit value.
The person providing the additional security guarantee for your loan is called the guarantor.
They're not required to pay any of your monthly home loan repayments, and they don't pay the lender any money.
It's only in the event you stop meeting repayments, that the lender has the right to seize the guarantor's limited guarantee amount that was pledged. Just to be clear, they're not responsible for the entire loan amount. It will only be the portion of the guarantor's property that's pledged which will be at risk.
This type of loan is often used by first-time homebuyers who may not have the necessary deposit, income, or credit history to secure a traditional mortgage.
What is a guarantor?
The person providing security (e.g. their own home equity) against your loan is called a guarantor.
It will usually be a close relative who has a good credit history and is financially stable.
What is LMI?
Lenders mortgage insurance (LMI) This is a one-off insurance fee that needs to be paid by the borrower to protect the lender in case it cannot recover the loan amount.
LMI is usually required if the borrower takes out a loan that's more than 80% of the property's value. Avoiding this is a benefit of a guarantor loan.
What is Loan-to-value ratio (LVR)?
Loan-to-value ratio (LVR)is an important concept. LVR is the loan value divided by the value of the property you're buying. The higher the LVR, the riskier the loan is to the lender. This means that the interest rates they offer will also likely be higher. Having a lower LVR is another benefit of a guarantor loan.
What is a guarantor?
The person providing security (e.g. their own home equity) against your loan is called a guarantor.
It will usually be a close relative who has a good credit history and is financially stable.
How will a guarantor help your home loan application?
Having a guarantor on your home loan application can have several benefits:
- You're more likely to be approved for a loan with a smaller deposit. This is because the lender knows that they have someone else to fall back on if you default on the loan.
- You can avoid paying for lenders mortgage insurance (LMI). LMI is an extra fee that you'd usually have to pay if you can only come up with a deposit smaller than the usual 20% of the property's value. This insurance essentially protects the lender in case you default on your loan, and it can add thousands of dollars to the cost of your loan. Having a guarantor means you won't have to pay LMI, which ultimately saves you money.
- You might get better loan terms. When you have a guarantor, the lender sees your loan as being less of a risk, which can lead to them offering you lower interest rates. This can save you money over the life of your loan.
- You may be able to borrow a larger loan amount. Again, having a guarantor gives the lender more reassurance that they'll be able to recover their debt in the event you default. As a result, they may also give you access to more funds, which can be helpful if you're looking to purchase a higher-priced property.
Example of how a guarantor home loan works
Let's assume that you're interested in purchasing a property that costs $500,000. (To make things simple, we won't be considering things like stamp duty or valuation fees.)
With a traditional mortgage, you would usually need a 20% deposit (that's $100,000 in this example).
By opting for a guarantor home loan, your guarantor pledges their home equity as collateral for your loan.
They may choose to pledge the full $100,000. Or, you can come up with a portion of the deposit and have your guarantor make up the difference.
For example, you might pay 5% of the deposit ($25,000) and the other 15% ($75,000) might come from your guarantor's pledged home equity.
You will be responsible for paying your own monthly mortgage repayments to the lender (not your guarantor).
In the event you can't meet your monthly loan, your guarantor will need to come up with $75,000 to pay the lender.
How much LMI would I pay without a guarantor providing security?
The amount of LMI you'd pay varies on various factors like the property value and current deposit value.
But to use the above example as an estimate, let's say you've only managed to save up $50,000 (a 10% deposit).
If you don't have a guarantor, you might have to pay about $12,000 in LMI.
Check out our LMI calculator to see how much you could save.
Drawbacks of guarantor home loans
While there are many benefits to the guarantor home loan structure, there are a few disadvantages you need to be aware of before you sign any papers.
- It's not easy to find a guarantor! In the vast majority of cases, it's only parents who fill the role of guarantor.
- Your personal relationship with the guarantor can come under strain if you fall behind on repayments and your guarantor is saddled with the debt.
Is there a minimum deposit for a guarantor home loan?
The deposit amount for a guarantor home loan varies between 5-15%. However, you might be able to get approval in instances where the guarantor guarantees the full 20%.
Are there any guarantor loan requirements
Each lender will have their own unique set of eligibility criteria to determine which applicants are
Here are some of the common requirements for who can be a guarantor:
- The guarantor needs to have sufficient equity in their own property.
- The guarantor is usually an immediate family member (e.g. parent).
- Some lenders may want to see that the guarantor has stable employment (but this usually isn't the case).
The lender will also want to look at the borrower's financial history to see if they meet other lending criteria. This would include providing the lender with credit reports detailing your credit score or credit rating and information about your personal loans or current employment.
Guarantor loans are also open to first-home buyers. But may also apply to those refinancing a new home for staying in or as an investment property.
Thinking of being a home loan guarantor?
When you go guarantor for someone, you're essentially agreeing to be responsible for their debt if they can't make the payments themselves. It's a big responsibility and not one to be taken lightly.
Before you agree to be a guarantor, there are a few things you should consider:
- Be clear about the terms of the agreement. What happens if the borrower misses a payment? Are you responsible for the entire debt, or just a portion of it? Know what you're agreeing to before you sign anything.
- Think about your own financial situation. Do you have enough equity in your own home to be a guarantor? Imagine the worst-case scenario where you have to pay the portion of the loan you intend to guarantee. Can you afford to take on this responsibility? If not, don't put yourself in a position where you could end up in financial trouble.
- Consider your relationship with the borrower. What if your loved one is unable to meet their monthly repayments? How would this affect your relationship with them?
Don't forget to seek your own legal advice before entering into a guarantor arrangement so that you're fully aware of the terms and risks.
Can I get a home loan with no deposit and no guarantor?
Whether you're looking to purchase your first home or refinance a new property, a guarantor loan works well in many cases.
But even if it's not right for your situation, don't worry. There are other no- and low-deposit home loan options out there to help you get on the property ladder:
We've reviewed them in more detail here. But as a quick summary, some of your options include:
- Gifted deposit: A loved one provides the deposit as a gift.
- Use superannuation to pay for part of the deposit.
- Utilise the First Home Owners Grant government program to pay for part of the deposit.
- Consider no deposit home loans
- Consider low deposit home loans
- Consider a 5% home loan
