If you’re going to balance the future of your home or property on someone’s reliability to pay their own mortgage, make sure you’re across the risks.
Nearly 40% of Aussies said it took them between two and five years to save for a deposit on a home, while 25% said it took them between five and 10 years1.
If you have a family member who wants to get into the market sooner than that, you may have discussed whether you’d be willing to speed up the process (if you’re in a position to) by going guarantor.
This is where you use the equity in your own property as security for the loan they’re taking out. It’s essentially a promise by you (the guarantor) to the lender, that the borrower will make the necessary repayments and if they don’t, or are unable to, you’ll repay the loan for them.
While there may be benefits for the person you’re going guarantor for (they mightn’t need such a big deposit or could avoid paying lenders mortgage insurance), here are some things to avoid before making a decision.
1. Not knowing what you’re signing up for
Depending on the lender (and each will have their own terms and conditions if they allow for this type of arrangement), you can use your property as security on someone’s entire home loan, the entire loan amount plus additional costs, or limit the guarantee to a portion of the loan.
The role of guarantor will generally be limited to immediate family members, but may include siblings, grandparents and even former spouses, depending on your lender.
Meanwhile, how long you act as guarantor will depend, but once this person’s loan has reduced beyond a certain level, you can ask to be removed as guarantor, although this will have to be approved by the lender and fees may apply.
2. Not considering changes in circumstances
You always want to hope for the best but over the term of this person’s home loan, there could be a point where they lose their job or become injured or ill and be unable to make repayments for a while.
For this reason, you may want to find out if they have a back-up plan, any emergency cash stashed away or personal insurance (what type and how much).
If things don’t go as expected, repayment of their home loan becomes your responsibility, so unless you have additional funds, worse-case scenario, you may have to sell your home to clear this person’s debt and there could also be flow on affects regarding your credit report.
3. Not giving much thought to your own bucket list
Going guarantor reduces your ability to borrow funds, so it’s important to think about whether you have other plans that could be affected – such as holidays or other big purchases.
You may also want to give some thought to your retirement. June 2021 figures (which assume you own your home outright and are pretty healthy) show individuals and couples, around age 67, who are looking to retire today, need aannual budget of around $44,818 and $63,352 respectively to fund a comfortable lifestyle2.
With that in mind, you don’t want a sudden liability, such as being called on as guarantor, to jeopardise your retirement plans.
4. Not expressing your expectations
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 to help make sure everyone is on the same page
- how long you expect to be involved and what your exit strategy as guarantor might be.
5. Not exploring other financial avenues
There may be other financial avenues that could work better for you and the borrower depending on your situation.
Could you gift a deposit?
If you can afford it, gifting a deposit might be something you’d prefer to do. A good deposit will reduce the amount your family member needs to borrow, and the interest paid over the life of their loan.
Going down this avenue also means any loss you incur will be limited to the amount of the gift.
Bear in mind, if you happen to receive Centrelink payments (or are planning to in the future), you’ll need to consider that a gift of this nature could impact your benefits, so do your research.
Could you go in as a co-owner?
When you buy a home with family members, you share responsibility for the costs involved while receiving the benefits of investing in property, depending on your arrangements.
It’s important to understand that as a co-owner you are included on the loan and only own a share of the property. If you sign as a joint borrower, you’re also equally responsible for the home loan so are equally liable for the entire debt with the principal borrower.
Again, it’s a good idea to document each person’s rights and obligations. For example, is the person who is going to live in the property going to pay you rent, which you would otherwise expect in an investment property situation?
Going in as a co-owner is a big commitment and you’ll need to understand the risks and get the right advice, so you’re across everything, including tax and possible Centrelink issues.
Could you let them save money by living with you?
If it’s your child you’re thinking about going guarantor for, you may be interested to know that many parents have adult children living at home rent-free to help them save for a home3.
With that in mind, you may prefer offering your child their old room for a while for low or no rent to help them get some more savings behind them.
Where to go if you need a bit of help
Acting as a guarantor is a serious legal responsibility and you may be required to get legal advice before a lender will accept the arrangement.
It may be worth speaking to your financial adviser about any potential risks, benefits and tax implications as well. If you don’t have an adviser but would like some advice, our directory could help you find one nearby.
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