You want to own a home, but what if you don’t have the 20 percent deposit most banks require, and want to take out a home loan with as little as 5% deposit? You have two options - get a guarantor home loan or take out Lender’s Mortgage Insurance (LMI).
Guarantor home loans can be a good option if you don’t have enough cash to meet the 20 percent equity criteria that apply to most home loans. Guarantor home loans are common among first home buyers in Australia. Young people will rarely be able to come up with the 20 percent property deposit requirement, so guarantor home loans are becoming a popular option for them.
On the other hand, the LMI is designed to cover any losses on the sale of your property in the event that you default on the loan. This insurance is designed to mitigate losses for the lender.
However, LMI can be costly, so many people are instead opting for a guarantor home loan. We have a separate article on LMI.
In this article, we shall talk more about guarantor home loans.
Here are some more details about guarantor loans to help you decide if this option could work for you.
What is a Guarantor Home Loan?
A guarantor home loan involves three parties – the creditor, the borrower, and a guarantor. In most cases, guarantors are the borrower’s parents. The guarantor uses a property they own, or equity in a property, as loan security.
In most cases, you can lend as much as 107 percent of the value of the property or equity.
In Australia, borrowers need to have Lenders Mortgage Insurance when the loan to value ratio (LVR) is more than 80 percent. However, there is an exception to this rule.
If you have a guarantor who is able to offer security on your loan, the lender is able to waive the insurance requirement.
It’s crucial to look into the best payment structure that will release the guarantor from their obligations as soon as possible.
In a guarantor home loan, all parties involved should enter the agreement with their eyes open. It’s best to consult a financial adviser or a mortgage broker to discuss all possible risks.
What Types Of Guarantees Are There?
There are various types of guarantor house loans. Knowing the difference between each type will help you find the option that works best for you and your guarantor. Here are the most common types of guarantees and what they mean.
1. Security Guarantee
In a security guarantee, the guarantor’s property serves as security. This guarantee type allows you to borrow 100 percent of the purchase price of the property. Most guarantor home loans belong to this category.
The security guarantee can either be a mortgage or a second mortgage on the guarantor’s property.
Under this agreement, the guarantor will fulfill all the obligations of the debtor. This means that the guarantor is obliged to pay off the loan including any interest and fees if the borrower defaults.
Since this arrangement is risky for the guarantor, the borrower should ensure that they have the means to support the loan. Failing to keep up to date with payments could mean that the property used to guarantee the loan is at risk.
The guarantor or borrower can request the removal of the guarantee if circumstances change. The lender will assess if the borrower has sufficient equity. There may also be other requirements for the release of the guarantee.
2. Income Guarantee Home Loan
If your income is not sufficient to pay the loan installments, you can opt for the income guarantee home loan.
With this loan type, the main guarantor is usually your parents. In addition to using the equity in their property to guarantee your loan, your guarantor will also guarantee your income.
For the income guarantee home loan, the property your new property acts as security for 80 percent of the loan. Your parents’ property will then cover the remaining 20 percent.
This loan allows the borrower to borrow as much as 110 percent of the property value. Just like the security guarantee, this waives the need for Lender’s Mortgage Insurance.
Acting as a guarantor means that your parents will be jointly and severally liable for the loan. This type of loan creates a number of obligations for the guarantor, so it is crucial to seek financial and legal advice before entering any loan agreement and to ensure that the arrangement will work for all parties.
Once the borrower’s income becomes sufficient to cover the loan repayments, the borrower can request the removal of the guarantee. The borrower will have to pay stamp duty based on the current value of the property.
3. Family Guarantee / Parent Guarantee
In the family or parent guarantee the loan, the guarantor uses equity from an existing property to serve as security. This loan allows the borrower to take out as much as 100 percent of the property’s purchase price.
Parties qualified to offer this guarantee include the borrower’s parents or legal guardians. A single guarantee cannot represent more than 50 percent of the guarantor’s security.
When the borrower meets the required loan to value ratio, it’s possible to request for the removal of the guarantee.
4. Limited Guarantee
Of the different types of guarantor home loans, limited guarantee loans are the least risky. Under this arrangement, the guarantor secures only part of the loan, not the entire amount. There are some points to bear in mind when considering this loan.
With a limited guarantee, the borrower can borrow up to 100 percent of the property value. The credit can also waive the need for Lender’s Mortgage Insurance.
In this arrangement, the guarantor covers the amount in excess of the 80 percent maximum loan to value ratio. You can use an online calculator to work out how much you could lend, but you can also calculate the amount using this formula:
Limited Guarantee = (Loan Amount/0.8) - Property Price
For example, if you take out a $440,000 loan against a property with a $400,000 property value, the limited guarantee will amount to $150,000.
Here, the guarantor needs to have enough equity in the property used as security. Most lenders will require an 80 percent debt ratio. If the guarantor owns a $500,000 property, total debts including the limited guarantee should not exceed $400,000.
The borrower or guarantor can ask for the removal of the guarantee before the end of the agreed term. In most cases, lenders will entertain these requests from between two and five years after setting up the loan.
Requests will have higher chances of getting approved in the following cases:
- The borrower has made regular payments for the past six months
- The loan to value ratio is at least 90 percent (the ideal LVR is 80 percent)
- The borrower can afford to make repayments
How Much Can I Borrow with a Guarantor Mortgage?
lenders allow borrowers to take out up to 110 percent LVR if they have to consolidate debts.
In many cases, the maximum loan is up to 105 percent of the property value.
What are the Benefits of Guarantor Home Loans?
The main reason people take out a guarantor home loan is to avoid paying for Lender’s Mortgage Insurance.
While the guarantor loan imposes obligations on the party providing the security, there is the flexibility to request the removal of the guarantor during the term, provided that all requirements are satisfied.
Another major advantage of a guarantor home loan is that it allows you to purchase the property of your dreams sooner.
Who Can be My Guarantor?
Most banks will accept parents, partners, and legal guardians as guarantors. Some creditors might allow other immediate family members, such as grandparents, siblings, and adult children to act as guarantors.
While it’s possible to ask friends and co-workers to act as guarantor, lenders are less likely to approve the loan in this case. If your guarantor is not your parent or legal guardian, it is advisable to seek professional advice.
The guarantor needs to be at least 18 years old, gainfully employed, and of sound mind. The property used as security has to be located in Australia or New Zealand. The guarantor also needs to be a citizen of any of the two countries.
If you do not have a guarantor, you may still be able to purchase a property with a friend and enter a co-ownership or co-borrower investment loan instead of a guarantee home loan.
Should I Act as a Guarantor?
Acting as a guarantor is a big commitment, even if you are helping your child buy a home. You need to consider the risks ensure that you are in a position to take on responsibility for debts should the lender fall on hard times.
After assessing the paying capacity of the borrower, ask yourself if you are willing to take the risk.
What are the Risks of Being a Guarantor?
Being a guarantor has no financial benefits. However, there are a number of risks.
If the borrower defaults on the loan, you will have to cover the repayment instalments due or you risk damaging your credit rating. If you take out a loan in the future, any unpaid balance will appear on your credit history.
Any defaults on the loan can impact on you and in serious cases can result in you having credit applications declined.
Before agreeing to be a guarantor, you should consider your plans for the next five years. Decisions of the lender will have implications for you.
Perhaps the biggest risk of acting as a guarantor is that you are putting your relationship with the borrower on the line. Even if relations break down between the parties, the guarantor remains liable.
Given these risks, it’s crucial to seek reliable and impartial advice. It’s also useful to discuss all available options to see if there are other ways to help out with the loan without being a guarantor.
Finally, think about the worst-case scenario. Do you have enough funds to pay for the loan if the borrower fails to do so?
When Can I Remove the Guarantee?
Removing the guarantee is possible in some circumstances. The best time to remove a guarantee is when the lender owes less than 80 percent of the property’s value. The chances of obtaining approval to remove the guarantee will be higher if the lender has made all repayments on time (at least for the last six months).
Removing the guarantee at the 80 percent threshold also means that the lender will not need to take out a Lender’s Mortgage Insurance.
Sensible, (Almost) Deposit Free Home Loans
Are you short on funds but need to take out a loan? Are your parents willing to assist you?
If your answer yes to both questions, a guarantor home loan could be the best option for you. Depending on the lender, guarantor loans could offer the following benefits
- Minimum savings requirement of only 5 percent.
- Lenders Mortgage Insurance waiver
- Early guarantee removal
- Limited guarantee liability for your parents or other guarantors depending on the agreed sum
Why Should I Get a Guarantor?
- You can borrow 100 percent or more against the purchase price of the property
- No deposit required
- Basic loan discounts and professional package are also available
- Approval rates are higher, and requirements are less stringent
Why Use Us for Your Home Loan?
- We earn from commissions through the lenders, at no extra costs to you. You don’t have to pay us directly.
- Guarantor home loans happen to be one of our specialties.
- Loan processing is part of the services we provide.
- We explain everything to you throughout the process of obtaining a loan, including your options, the risks involved, and the options open to guarantors.
Let Us Help You
Find a Better Rate (Mortgage Broker Melbourne) will lay out all the options available to you. We will also assist you in making the most practical and financially-sound decisions when it comes to taking out a guarantor home loan.
We will also advise you on which companies offer the most affordable rates and how to get in touch with them.
Disclaimer: All the facts outlined in this text is for general information purposes only and should not be construed as financial, investment or legal advice. Always seek professional financial or legal opinion before entering any commitment.
Mortgage Broker Melbourne Victoria Australia © 2018 Mortgage Broker Melbourne
Official mortgage broker of www.propertyinvesting.com