One of the largest obstacles most first home buyers will face is saving for a home deposit. Taking into account regular costs like rent, groceries, and utilities, putting aside enough funds for a deposit will likely take a few years at least.
Generally, lenders require a deposit of 20% of the property value. Some first home buyers with a smaller deposit may be approved for a mortgage, but this will usually mean paying Lenders Mortgage Insurance (LMI) on top of loan repayments.
Fortunately, there is a way for first home buyers to step on the property ladder sooner and avoid incurring the charges of LMI. That is by having a guarantor on your mortgage, which is also called taking on a family guarantee, also known as security guarantee, a guarantor home loan or a guarantor loan. For the sake of ease and consistency, we will be using term family guarantee in this article from now on.
This article will explain what family guarantees are, who can use them, how they work, as well as the benefits and risks involved.
In simple terms, a family guarantee is a type of home loan that lets a family member, usually a parent, ‘guarantee’ your mortgage when you can’t supply a large enough deposit. They do this by providing their property, or a portion of their property’s equity, as security in lieu of a deposit.
A guarantor is usually a parent who agrees to let you use their property as security for your home loan. Some lenders also allow other relatives, like an aunt or a sibling, to act as your guarantor.
You can act as someone’s guarantor if:
You understand that this may affect your credit and by extension your capacity to borrow.
For a home buyer, having a guarantor can have several benefits.
You can use a guarantor if:
A family guarantee usually comprises of two separate loans. The first loan is secured by the property you are buying and is 80% of the property’s value. The second loan is the balance of the funds required to complete the purchase. It is secured by the property you are buying plus the guarantor’s entire property value (Full Guarantee) or a portion of the property’s equity (Limited Guarantee). As the borrower, you will need to make the repayments for both loans.
A limited guarantee is usually preferable for the guarantor (see below for an explanation).
Family guarantees broadly fall into one of two categories, limited and unlimited.
Limited guarantee: In this type of loan, a cap is set on how much the guarantor would be liable to pay, should the borrower default.
Unlimited guarantee: This loan type means the guarantor is agreeing to be liable for 100% of the loan you are receiving.
Paul and Joanne want to purchase their first home, valued at $500,000. Their purchase costs to cover solicitors, registrations etc are $4000. Their lender is satisfied they earn enough income to service their loan repayments, however, they only have $25,000 in savings (5% of $500,000).
Normally, they would need to provide a 20% deposit and cover costs, equalling $104,000 (20% x $500,000 = $100,000 + $4000 costs) to avoid paying LMI. This leaves them needing an extra $79,000 ($104,000 – $25,000).
Joanne’s father — who owns a property valued at $1,000,000 — agrees to be their guarantor. This means the bank can lend Paul and Joanne the extra $79,000 and secure the loan with Joanne’s father’s property as well. Paul and Joanne may now take out the loan, without saving more (other lending conditions may apply). When their property’s equity reaches 20%, they can apply to release their guarantor from the loan.
A family guarantee is meant to be a short-term strategy to get you on the property ladder sooner. Your intention should be to take the guarantor off your loan as soon as possible.
With that in mind, here are some strategies to help you pay off your loan faster so you can remove your guarantor from the loan:
These are just a few possible strategies you could employ to remove a guarantor sooner. You can discuss these and more strategies in greater detail with a Nectar mortgage broker. Contact us today.
Using a guarantor may be a winning situation for a borrower, but it’s also important to consider the risks from the guarantor’s point of view.
Be sure to speak with a professional before you decide on becoming a guarantor or not. Feel free to contact us, we’re more than happy to help.
For the most part, a family guarantee will have the same interest rate as a normal home loan. However, as you are effectively borrowing 100% of the property value, your repayments will be higher until you are able to lower the LVR.
Some lenders will accept a guarantor for an investment property loan.
There are several things you should consider before deciding what loan you should go for. Get in touch with Nectar and we can discuss strategies to help you reach your financial goals.
If you can’t secure a family guarantee or if you would rather not put that responsibility on someone else, there are alternatives.
If you’d like to discuss more low deposit options or other strategies that could help you get on the property market, talk to us.
Please note:
This article is intended as a guide, designed to help you better understand family guarantees. It is not a substitute for advice from a professional mortgage broker.
Be advised that in the current market, as interest rates and loan repayments increase, the risk of a borrower defaulting on their loan also increases. If you are considering becoming a guarantor, be sure to seek legal advice before finalising any agreements.