Saving up for a deposit can be hard work – especially if you’re working towards the 20% needed to avoid lenders mortgage insurance (LMI). Asking someone close to you, like a family member, to act as a guarantor is one way to shortcut the process and get you into your first home faster – letting you get on the property ladder with a lower deposit and without paying the cost of LMI.
A guarantor is someone (in the case of a home loan, usually a close family member) who puts up extra security for your home loan. They don’t need to give you or the lender any money to do this, but they are accepting any obligations associated with the guarantee. The most common guarantee a lender will consider for a home loan is a limited security guarantee.
With a security guarantee, a guarantor is offering up equity in their own home as security against your loan. The equity they have available to offer is calculated by looking at the market value of their property, minus the amount they still must repay on their own loan.
This guarantee doesn’t cover the whole loan amount – rather it will cover whatever amount is required to top up your deposit to the 20% you need to avoid LMI. Depending on the lender, sometimes a little extra can also be added to help you cover costs such as stamp duty.
Here’s how it looks in numbers.
The value of the property you want to buy: $600,000
The bank assesses your ability to service a loan amount of: $600,000
You have a deposit of: $60,000 – i.e. 10%
To avoid LMI, you’ll need an extra: $60,000 – which is the amount of equity in their home your guarantor will offer as security. No money changes hands between the guarantor and lender.
Once you have paid down your own mortgage – or your property value increases – so the equity in your home is enough to cover the guaranteed amount, you can then apply to have the guarantor removed.
It’s important to note that even if you have the support of a guarantee, you will be responsible for ongoing repayments for the full loan amount.
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If something happens where you are no longer able to service your ongoing home loan repayments, the lender will look to recover what is owed to them. If no other agreement is reached, the lender has the right to sell your property – and if the sale doesn’t cover what you owe, the lender can then turn to your guarantor for the amount they guaranteed ($60,000 in the example above). Their liability is strictly limited to agreed terms of the guarantee.
If you’re lucky enough to have someone close to you agree to act as a guarantor, you’ll still need to meet all the other lending criteria required to qualify for a home loan. A guarantee isn’t necessarily going to make you a stronger candidate for a loan, but it will help you avoid the extra cost of LMI and potentially get you into the property market faster than you would if you had to wait until you saved the full 20% deposit you were working towards, on your own. It’s also good to note that a limited security guarantee isn’t the only type of guarantee out there – we touch on some of the others, here.
Getting support from a guarantor isn’t something that should be entered lightly – it’s super important everyone involved understands their obligations and what it is they’re agreeing to. While a limited security guarantee limits the liability of a guarantor, it isn’t completely without risk, so it’s important to seek advice from an expert to consider the appropriateness of this kind of agreement in the context of your own personal situation. Where appropriate, you may even consider seeking legal advice before entering into any sort of guarantee agreement.
Do you still have questions about the details surrounding home loan guarantors? Get in touch with a first home buyer specialist at First Things First.