How do guarantor loans work?
Your guarantor will provide a guarantee for your home loan which is secured on their property. In most cases, this is your parents assisting you to buy a home. The idea is for you to get into the property market sooner. Once you have paid off part of your loan or your property has increased in value, then you can apply to remove the guarantee. Some lenders now allow you to limit the size of the guarantee.
What are the benefits of a guarantor loan?
Guarantor loans have several benefits for the borrower. You don’t need a deposit, allowing you to buy a home sooner. You save money by not paying a Lenders Mortgage Insurance (LMI). You can also consolidate some minor debts, such as credit cards, when you buy your home. You can limit the size of the guarantee.
Who can be a guarantor?
Most banks will only allow parental guarantees, that is, a guarantee from the borrower’s parents. Some lenders can consider guarantees from immediate family members such as siblings, spouses grandparents, de facto partners or adult children. If someone other than your parents are your guarantor, then you may need to meet additional lending criteria to qualify for a home loan.
What are the risks of being a guarantor?
On paper, the guarantor is ultimately liable for your home loan should you default. There is a big fear that banks move quickly to sell your home to cover the remaining debt but the reality is that banks try everything to solve the problem before taking this drastic decision. The reason is that there is often a significant process and cost involved in trying to sell your home. Chances are, they will struggle to break even going down this path so they would much rather that you keep paying your mortgage. To do this, they will want to work out why you’re having trouble managing your loan repayments and whether a solution can be found.
How is the mortgage for the guarantee structured?
The loan is secured by both the property that you are buying and the property owned by the guarantor. It is quite simple, and if you use a limited guarantee then the guarantor can reduce their exposure to your mortgage. The structure is very similar if your parents already have a home loan on their property. The guarantee for your loan is secured using a second mortgage behind their current loan.
How much is the guarantee limited to?
For most guarantor loans, the lender will limit the guarantee secured on the guarantor’s property. This means they are not liable for the entire amount of the loan, only a portion of it. The size of the limited guarantee is calculated as:
The limited guarantee = (Loan Amount – 0.8 of the purchase price) divided by 0.75.
For example, if you are buying a property for $500,000 and are borrowing $525,000 to cover your expenses such as stamp duty then the calculation would be ($525,000 loan amount – (0.8 of $500,000 purchase price)) divided by 0.75 = A limited guarantee of $166,666
What if something goes wrong?
Let’s that you’ve recently been made redundant from your job as a maths teacher. Lenders take the view that you have a good chance of getting another job soon. In the meantime, the bank may reduce your mortgage repayments for a period until you’re able to find work again.
Whose property will be sold first?
Should you still not be able to make your home loan repayments, lenders will always act on your property first before making the guarantor liable to pay out the outstanding debt. Of course, it’s important to bear in mind that repossession will only commence if the mortgage has been in arrears for 90-180 days.
Don’t forget the limited guarantee
What if the sale of your child’s property isn’t enough to cover the home loan? Remember, there is only a limited guarantee in place which means the guarantors are only liable for up to an agreed amount. This is usually around 20% of the purchase price plus the costs of stamp duty, conveyancing fees and other associated home loan costs.
For example, if the outstanding debt is for $700,000 but the limited guarantee is for only $210,000, the guarantors are only liable to cover the outstanding mortgage up to $210,000. Obviously, if the property sold for $700,000 or more they wouldn’t have to worry about anything. However, if the property only sells for $440,000, the guarantor will have to cover up to $210,000 with equity in their property to cover the shortfall but they won’t be liable for the remaining $50,000. Of course, if the property sells for $590,000, then the guarantor would be liable for $110,000.
There are still more option left!
If the guarantors don’t have the equity or savings to cover the outstanding amount, they can apply for a second mortgage on their property or a personal loan. If these avenues have been exhausted, banks will sell the guarantor’s property but will only take enough of the proceeds to cover the home loan up to the limited guarantee. The rest of the sales proceeds will go to the guarantors.