Saving up to buy a home can be a long hard slog. If you’re struggling to save enough you might be able to ask a family member to act as a guarantor on your loan.
A guarantor, (also known as a family guarantee or security guarantee), is responsible for paying back the entire loan if the borrower can't. The property being purchased will typically be used as the main security for the loan that’s being taken out, with the guarantor’s property usually providing additional security.
It’s essentially a promise by the guarantor, to the lender, that the borrower will abide by their responsibilities. And, if they don’t or are unable to, the guarantor will repay the loan for them.
It’s important to be aware that not all providers offer a family guarantee, and they each have their own terms and conditions. You will need to check directly with the provider you’re considering if you want to use a guarantor for your home loan.
What are the benefits of using a guarantor?
Depending on the lender, your financial situation and the terms of the guarantee, having a guarantor means:
- you might not need to save a large deposit
- you may avoid having to pay lenders mortgage insurance (LMI) if you can bring your loan to value ratio below 80% (where the guarantor is providing their property as additional security)
- it might increase your borrowing ability.
How it works
Sam and Mike have saved a $50,000 deposit. The house they want to purchase is valued at $500,000. They want to borrow $450,000.
Loan amount ÷ property value = loan value ratio (LVR)
$450,000 ÷ $500,000 x 100 = 90%
An LVR of 90% usually means lenders mortgage insurance is required. This is an added cost. To reduce the LVR Sam and Mike need to increase the total security value. Usually the property is offered to secure the loan, so if Sam and Mike had someone act as guarantor, and the guarantor provides an additional $62,500 as security, it increases the total security value and reduces the LVR.
Loan amount ÷ (property value + guarantor security) = loan value ratio (LVR)
$450,000 ÷ $562,500 = 80%
Depending on the financial institution, an LVR of 80% would usually not require LMI, saving Sam and Mike a significant amount.
These calculations don’t include other upfront costs such as stamp duty, bank fees or conveyancing fees. They also do not consider any loan servicing fees that may apply. Remember to take all potential costs into account to give you a good idea of the deposit you’ll need, and the likely LVR.
Depending on the lender, guarantors can guarantee the entire loan amount plus interest and reasonable costs, or limit the guarantee to a portion of the loan.
How long someone acts as a guarantor will depend on various factors, but once the loan has reduced beyond a certain level, the guarantor can ask to be released. This will have to be approved by the lender, and fees may apply.
Who can act as a guarantor?
Guarantors generally need to be a spouse or partner, and each provider has its own terms and conditions.
Depending on the loan provider and their eligibility rules, guarantors may also include:
- extended family members
What happens if you default on your loan?
If the borrower can’t make their home loan repayments, the guarantor becomes responsible for paying back the entire loan plus interest and reasonable costs.
If the guarantor can’t repay the loan, they could face bankruptcy. Or the lender could repossess their property if it was used as security. In the worst-case scenario, a guarantor could lose their home if the borrower cannot meet their obligations.
There are other potential risks and considerations, especially for the guarantor. These include:
- Their credit rating could be put at risk if the borrower doesn’t repay the loan.
- By tying up the equity in their home, they may not be able to use it if they need to.
- Considering what would happen if the borrower becomes sick or injured and is unable to work and make their mortgage repayments.
- Relationships could be affected if things don’t go to plan.
Acting as a guarantor is a serious legal responsibility. It’s vital that any potential guarantor understands what’s involved and seeks legal and financial advice. Some lenders may request this happens before they’ll accept the arrangement.
Other things to consider
Before making any decisions, it’s important to discuss and consider:
- both parties’ circumstances and expectations over the life of the loan
- having an agreement in place can help make sure everyone is on the same page
- how long the guarantor expects to be involved and what their exit strategy is.
If you’re considering going guarantor, or need one to help you purchase a home, speak to your financial adviser about any additional risks, benefits and tax implications. If you don’t have an adviser, call us on 131 267 or find one online.
This information is provided by AWM Services Pty Ltd (ABN 15 139 353 496), is general in nature only. It hasn’t considered your personal goals, financial situation or needs. Before deciding what’s right for you, it’s important to consider your particular circumstances and read the relevant product disclosure statement or terms and conditions available from AMP at amp.com.au or by calling 131 267 or by emailing email@example.com.
All information on this website is subject to change without notice. Although the information is from sources considered reliable, AMP does not guarantee that it is accurate or complete. You should not rely upon it and should seek professional advice before making any financial decision.
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