Guarantors traditionally use their own property (or the equity in it) as security to guarantee either an entire loan or a portion of it.
What are the types of guarantees?
Guarantor loans have become popular in recent times as they can reduce the upfront cost of a home loan, particularly when it comes to the deposit. These types of loan are structured in such a way that the loan is secured by both the property you are buying and the property owned by the guarantor. Standard types of guarantees are:
- Security guarantee
First time home buyers with little or no deposit will often use this type of guarantee. The guarantor uses real estate they own as additional security for the mortgage in question. If the guarantor has a loan on their property already, the bank can usually take a second mortgage as security.
It can also be known as a Family Guarantee when the guarantor is directly related to borrower ie: Parents, siblings, grandparents, spouses, and de facto partners.
- Security and income guarantee
Guarantors of this guarantee are most often parents helping their child who is a student or who has insufficient income to buy a property. The lender will then use the parents’ property as additional security and rely on the parents’ income to prove that the loan is affordable. These ones are not widely available.
Limited guarantee – Security
The guarantor only guarantees a part of the loan. Most often, this guarantee is used with security guarantors to reduce the potential liability secured on the guarantor’s property. Guarantees can either be limited or unlimited, depending on both the guarantor’s wants and the lender’s requirements. A limited guarantee reduces the guarantor’s exposure to your mortgage loan.
Who can be a guarantor?
Lenders have different requirements for loan guarantors but, generally, guarantors should:
- Have equity in their property and a stable income to satisfy lenders
- Have a good personal credit rating
- Be an Australian citizen or a permanent resident
- Be above 18 (lenders will usually have an upper age limit depending on their financial position)
How much can you borrow with a guarantor?
With a guarantor loan, you can borrow 100% of the property purchase price or even slightly above that. While the majority of lenders will only give out 100% of the property value even if there is a guarantee, some may offer slightly above the price.
How can you benefit from guarantor loans?
Guarantor loans have several benefits, depending on your circumstances and financial goals. With a guarantor loan, generally speaking, you can:
- Buy a property as early as now (as you don’t need a deposit)
- Get into the property market faster
- Avoid the cost of lender’s mortgage insurance (LMI)
- Unlock better loans with more favourable rates
- Limit the size of the guarantee
Is there a risk in guarantor loans?
Despite the benefits listed above, guarantor loan can also be risky. The guarantor is ultimately liable for your loan if you fail to make repayments, so if you can’t repay your loan, there is a possibility that your guarantor’s property will completely become the bank’s property. Usually, though, the bank will take action on your property first before making your guarantor pay the outstanding debt.
In cases where guarantors don’t have the equity or savings to cover the debt, they can either apply for a second mortgage on their property or a personal loan. Only after these avenues have been used up will banks sell their property, only taking enough of the proceeds to cover the loan up to the limited guarantee. The rest of the sales proceeds will then go to the guarantors.
Fortunately, guarantors are only liable to repay the amount they guarantee and once that amount is repaid, they are released from further liabilities.
When can you remove the guarantee?
Many guarantees are put in place because the borrower cannot put together the required deposit, and so removing the guarantee depends on how much the property appreciates in value and how many extra repayments the borrower can afford to make. Most people are able to remove the guarantee between two and five years after they initially set up the loan.
You can (and should) apply for the removal of the guarantee upon meeting the following conditions:
- Your loan is for less than 90% of the property value (ideally 80% or less because if you owe more than 80%, you may have to pay the LMI)
- You have not missed any payments in the last six months
- You can make repayments without any assistance (income guarantee)
What if you want to be a guarantor?
Guaranteeing someone else’s loan is a major commitment so before making the decision, you should do the following:
- Assess if you can afford to be a guarantor and whether the borrower can afford the loan
- Consider your relationship with the borrower
- Seek independent legal and financial advice to make sure you understand the loan process and its impact on your financial situation
- If you are asked to guarantee a business loan, learn everything you can about the company involved (including its financial status)
- Determine the extent of your liability and responsibilities if the borrower defaults
- Limit your guarantee in terms of amount and time (if possible)
- Make sure you can cover the monthly repayments without outside help
If, after careful consideration, you have decided to be a guarantor, you should get a copy of the loan contract as it will give you relevant and accurate information regarding the loan.
If you change your mind about being a guarantor, ensure that you will make this decision before the borrower receives loan approval and signs the contract of sale.
Can you sell your property if you are a guarantor?
Before you sign up to the guarantor agreement, you should be aware that you may be unable to sell your property or borrow on your mortgage (top-up). The lender may have options available which can be utilised.