The risks and rewards of a guarantor loan

Fact Checked
Updated 15/03/2024
The risks and rewards of a guarantor loan

Time to read : 5 Minutes

If you're a first-time home buyer struggling to gather a substantial deposit, a guarantor loan could be the answer to owning your own home sooner. This means involving a third person or persons to guarantor your home loan.

Guarantor loan real-life example:

Ted and Sam have saved their $50,000 deposit, and are eyeing a $500,000 home. 

With their deposit covering 10% of the purchase price, they’d typically need to pay Lenders Mortgage Insurance (LMI) for the remaining 10%. This can run to around another $10-15K.

However, with a guarantor stepping in, the guarantor can contribute an additional $50,000 (equivalent to the remaining 10%) from their own home equity. In this case, Ted’s mum and dad agree to guarantor the purchase of Ted and Sam’s home, using the equity in their own.

This effectively increases their home loan security to 20%, eliminating the need for LMI. It’s also possible for Ted’s parents to guarantor $100,000 of their home equity, providing the entire deposit for their home loan.

Sounds good, right?

It can be – and going guarantor is a way for a family to help younger members into a home of their own – but there are specific risks and obligations involved if you’re considering guaranteeing a loan for anyone, or if you’re asking members of your family to guarantor a loan on your behalf.

What is a guarantor?

A guarantor is someone who provides additional security for your home loan, allowing you to purchase your property with a smaller deposit.

Typically, lenders prefer guarantors to be close relatives, such as parents, grandparents, or siblings. Some lenders won’t allow a guarantor to be anyone but your parents.

How does a guarantor home loan work?

With a guarantor home loan, the guarantor offers a portion of their home equity as security for the home buyer’s loan. In the example above, Ted’s parents’ home equity acts as additional security for their lender, enabling Ted and Sam to buy their home with a smaller – or even no – deposit.

There are essentially two home loans involved:

  1. The loan of the new $500,000 property at 80% of the value (so a mortgage of $400,000).

  2. The equity loan of $50,000 secured against Ted’s parent’s home.

(We’ve established that Ted and Sam saved up their $50,000 deposit, and presumably the monies for stamp duty as well).

The benefits of a guarantor home loan

  • Reduced Deposit: A guarantor loan lets Ted and Sam own their own home sooner (i.e. before prices rise any further. The new homeowner only needs a small deposit or sometimes no deposit at all.

  • Avoiding (LMI): By providing additional security, a guarantor loan can help Ted and Sam avoid the cost of LMI, potentially saving thousands of dollars.

  • Lower Interest Rates: Some lenders offer discounted interest rates for guarantor home loans, making the mortgage more affordable. This is because the lender has additional security.

  • Limiting Liability: Guarantors can limit their liability by specifying the amount of the guarantee, reducing their financial risk. In our example above, Ted’s parents are only on the hook for the $100,000 they agreed to cover. This is unlikely to see them lose their house – but it’s a very good reason to read your guarantor loan contract carefully, and have your solicitor check it.

As you can see, most of the benefits of guarantor loans lean towards the new home buyer, not the guarantor. 

Be aware: guaranteeing a loan for your children does come with risks, and most of these fall on the guarantor. 

The risks of going guarantor for a home loan

While acting as a guarantor can offer significant benefits, it's essential to understand the associated risks. 

As guarantors, Ted’s parents are liable for the outstanding debt owed by Ted and Sam. If the couple default on their mortgage repayments, the lender will expect the repayments to be covered by Ted’s parents.

Guarantor’s Warning: this is particularly important because Ted’s parents secured Ted’s loan with their own property. Their home is at risk.

How much of a risk is this?

Realistically, lenders will explore many alternative solutions before resorting to selling a guarantor's property to cover the debt. They also prioritise covering the outstanding debt up to the limited guarantee, ensuring fairness to guarantors.

In addition, they typically aim to resolve funding issues before resorting to property seizure, and they’d prioritise Ted and Sam’s place over his parents’.

Lenders aren’t in the business of holding real estate. They’d rather find a workable way to adjust the loans – and they’re required by law to try. This is where hardship clauses come in.

Lenders Are Cautious:

Lenders are also required by law to insist that potential guarantors seek independent financial advice to assess for suitability. Brokers must also ensure that guarantors understand all of the potential risks involved in guaranteeing a home loan for a family member. 

If you’re going to guarantor a home loan, you’ll be required to sign a document that says you have sought independent financial and legal advice – and of course this should be done truthfully.

Going guarantor also means agreeing not to sell your home while it’s being used as security for another property.

Releasing your Guarantor:

In our example above, Ted’s folks will remain on the mortgage until Ted and Sam’s underlying loan is refinanced, special arrangements are made with their lender, or their loan is paid off. 

Depending on the specific lender's policies, Ted’s parents can be released from the loan once the young couple has built up sufficient equity (usually around 10% to 20% of the property's value). At this point, the properties aren’t connected any longer and Ted’s parents can do as they wish.

While guarantor loans can expedite the home buying process, they require careful consideration and planning. If you're interested in exploring guarantor home loans or other no deposit home loan options, contact a mortgage broker who specialises in these loans. Not all of them do. 

The bottom line

Acting as a guarantor demands careful consideration. 

Before committing to guarantorship, explore alternative options and assess if other no deposit home loan arrangements may be better suited to you and your child.

If you choose to guarantor your child or sibling’s home loan, seek independent financial and legal advice – and definitely speak to a specialised broker. 

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