February 20, 2017
Broadly speaking, when it comes to home loans there are two types of guarantees: a servicing guarantee and a security guarantee:
- A Servicing Guarantee is where the guarantor agrees to help with the loan repayments (ie to help “service” the loan) where the borrower isn’t able to show they can do this on their own. A servicing guarantee is usually only permitted between spouses or de facto partners. At the time of writing, we know of no lending solution where a parent can be a servicing guarantor for their child, for example.
- A Security Guarantee is where the guarantor agrees to let the loan be secured against their property as well as the borrower’s property, to reduce the risk to the lender (to a point where they’re comfortable approving the loan). In this scenario, the borrower is still proving that they alone can afford the repayments.
For most scenarios we see, therefore, your guarantor is someone (lenders usually require it to be your parent, spouse or de facto partner) who has equity in property and is willing to use it to help you qualify for a loan.
Equity is when there is a big gap between how much you owe your lender and what your property is worth. If, for example, your parents have a $500,000 house and they only owe their lender $100,000 against it, then they have $400,000 worth of equity.
Now if you’re buying a house of similar value, then that’s plenty of equity for them to be able to help you out if they’re willing for your loan to be secured against their property as well. They don’t need to contribute any payments, and are free to decide how much they are willing to contribute and for how long.
To understand this in a bit more detail, read this blog post about LVR (loan to value ratio) first. After that, the only thing to say is that in the above scenario the LVR is calculated as [your debt plus your parents’ debt] divided by [your property value plus your parents' property value], which would come out well and truly under 80%.
It’s important to note that in order for the guarantee to work, generally speaking, both you and your guarantor need to be at the same lender. For example, if your parents already have a loan with a particular lender, in order for them to be your guarantor, you’ll have a choice of two options:
- Get your loan with the lender your parents are already with
- Have your parents refinance to the lender you want to go with
There is also the possibility of what’s known as a “second mortgage” which allows you and your parents to be at different lenders, but that can get messy (particularly when it comes to discharging the guarantee years later) and we generally view it very much as a last resort.
As your lender will have two properties (the Guarantors and the house you’re purchasing) as security on this loan, you’ll find that you may enjoy some or all of these benefits:
- You may need a smaller deposit than if you were applying for the loan on your own;
- The lender may offer you a better deal; and
- You won’t need to take out Lenders Mortgage Insurance (LMI) which can be a huge cost saver.
Because your Guarantor will become ”jointly and severally liable” for your loan if you were to stop making repayments, we highly recommend they speak with a Financial Advisor to make sure they are making decisions in their best interest.
If you want to know more about how borrowing with a Guarantor works and find out the intricacies of different lender policies and how they affect you then contact the Team at Mortgage Choice in Kingsley on (08) 9309 4780 today.
Here are some of our other relevant articles that you may enjoy reading:
• First Home Owner Grant changes - how do they affect me?
• I have 10% deposit. That’s enough to get a 90% home loan right?
• Should I get an interest only (IO) or principal and interest (P&I) home loan?
• What is an Offset Account?