March 24, 2016
What is a Guarantor?
There are many lenders that will allow a related third party to offer additional security to assist a family member to buy their own home. The person offering this assistance is referred to as a guarantor.
Being a guarantor is different to being a co-signer or co-applicant. A co-signer or co-applicant is included on the loan and is responsible for the whole loan until it is completely repaid. However, a guarantor is linked to a loan by a guarantee. This guarantee can be released and the guarantor's responsibility can be stopped before the loan is completely repaid.
The borrower must be capable of servicing the whole loan on their own income.
How does it work?
A guarantor offers the equity in their own property to be used as an added security measure for the borrower's loan. The primary security for the loan will be the borrower's property. The lender will also take a mortgage over the guarantor's property. However, this mortgage will not directly support the loan but will be used to support a guarantee from the guarantor.
Who can be a Guarantor?
Lenders usually limit guarantors to immediate family members of the borrower. Typically, this would be a parent however guarantors can include grandparents and siblings. There are some lenders who will allow extended family members and ex-spouses to be a guarantor to a loan, but this does vary depending on the lender.
How does having a guarantor help the loan application?
By having a guarantor it may allow some homebuyers who have insufficient savings for a deposit, but are capable of making the required home loan repayments, to secure additional funds to purchase a home.
Many purchasers find saving for a deposit a very difficult and daunting part of buying a home, especially when they are also paying rent. By having a guarantor, the borrower may be able to borrow the full purchase price and in some cases even the associated costs with purchasing a property. But again this does vary from lender to lender, and some lenders will still insist that borrowers need to provide some of their own equity towards the property purchase, even if there is a guarantor.
Another advantage of having a guarantor on a loan is that the borrower may save thousands of dollars by avoiding Lenders Mortgage Insurance (LMI). Usually, LMI is compulsory for home loans where the loan is more than 80% of the property's value. LMI is a type of insurance that lenders use to cover the additional risk of high Loan to Value Ratio (LVR) lending. Even though LMI protects the lender against the borrower defaulting on the loan, the borrower has to pay the premium.
The amount of the guarantee will depend on the chosen lender's policy. The guarantee can range from the full loan amount to as little as 20% of the loan (where the loan is for 100% of the purchase price).
Once the borrower has built up some equity in their property, the guarantor can request to be released from the loan. The time frame to reach this stage will vary depending on such factors as; the original deposit saved, the number of extra loan repayments made and whether the property has increased in value over the time period.
Here is an example of how a borrower avoids LMI due to a guarantor providing additional security
A borrower would like to buy a $400,000 property and will need to borrow $380,000. This loan has an LVR of 95%, which would incur LMI.
If this borrower has a family member willing to offer a guarantee for their home loan, using the equity in their own property as added security, the LVR would reduce and as a result, the need for LMI would be avoided. This would save the borrower approximately $11,600.
The borrower may have to pay some other fees at the time the guarantor requests to be released from the loan, however this will depend on the lender. This can include a fee for the lender to revalue the primary security property, as well as any lender discharge fees.
What are the consequences for the guarantor if the borrower is unable to pay back the loan?
If the borrower cannot pay back their loan according to the terms of the contract, the lender can take legal action against the borrower, and in some cases, the guarantor. The guarantor will be liable for the amount detailed in the guarantee.
For advice on being a guarantor, or having a guarantor on your home loan - call me today at Mortgage Choice in Perth on (08) 9485 0090.
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