How do guarantor loans work?

How do guarantor loans work?

Guarantor loans are often honed as the ‘holy grail’ to home ownership or at least to getting an otherwise borderline home loan application approved. Whether you don’t have enough money saved for the standard 20% deposit, or you’re having trouble getting a lender to approve your application, a guarantor loan could be the answer you’ve been looking for.

What is a guarantor loan?

A guarantor loan is one where a ‘guarantor’ (generally a family member) signs onto your loan and in doing so, increases your equity and chances of approval. The more equity you have, the easier it will be for a lender or bank to justify approving your home loan.

For loan seekers who do not have the standard 20% deposit, having a guarantor sign on to the loan can often be the difference between having a home loan application approved or rejected. In some cases, it can also help you avoid paying Lenders Mortgage Insurance (LMI).

How do they work?

They work by having the guarantor offer up part of their home as equity in order to increase yours. In most cases, guarantors are usually limited to family members, namely parents, although sometimes siblings, grandparents or extended family will be accepted. The exact policy depends on the lender.

Despite being signed onto the loan, guarantors do not have any rights over the property. They are however, usually required to step in if the mortgage holder begins to lapse on payments. As such, agreeing to be a guarantor is a big responsibility.

How much can I borrow with a guarantor loan?

With a guarantor signing onto the loan, borrowers can generally take out much higher loans than otherwise possible. With a guarantor, many lenders will offer loans of up to 100% of the purchase price. Some will even go as high as 105%. To find out what you could be approved for, it’s best to ask your lender as it will differ depending on your circumstances as well as the lender’s policies.

Do you need a deposit with a guarantor?

Whether or not you need a deposit will depend on the lender. With a guarantor signing on, while some lenders will accept an application with no deposit, others will still expect as least a 5% deposit in genuine savings. It will also depend on how much equity your guarantor is willing to secure you for.

Having a guarantor can also be beneficial even if you have a 10 15% deposit saved since it can help you to avoid paying Lenders Mortgage Insurance (LMI).

Who can be a guarantor for a loan?

In most cases, the guarantor of a home loan will be a family member such as a parent or even a sibling, grandparent or extended family member. The exact policy will depend on the individual lender. In some cases, friends of the home loan holder will take on the role of a guarantor although this is more unusual. Being a guarantor is a big responsibility and guarantors should be sure to think about the impact it would have on them if the home loan holder was to default or not be able to keep up with repayments.

To be a guarantor, you need to have equity to offer up which means guarantors are usually required to be home owners themselves. In addition, you will need to be over 18 and, in most cases, an Australian citizen or permanent resident. Sometimes the guarantor will also need to have a stable source of income although in most cases being a home owner is the main requirement.

It is important to keep in mind that as a guarantor, you a using a portion of the equity in your home in order to secure the loan. This means that worst case scenario, if the home loan holder was to default on payments, you would have to step in and possibly sell your own home in order to cover the costs.

What does a guarantor have to provide?

Documents

A guarantor will usually have to provide evidence that they would be able to pay the loan if the home loan holder was to default. This could include proof of equity (for example, a title deed to their house) as well as bank statements.

Checks

The lender will likely check a guarantor’s credit before approving their guarantor status. As a guarantor, you are security for the loan and will be expected to step in if the home owner can’t meet their payments. As such, it is important that the lender is confident you have this ability. If you have a low credit score, it is unlikely that the lender will approve you as guarantor to the loan.

What happens if a guarantor cannot pay the loan?

If the home loan holder defaults, it is up to the guarantor to handle the home loan repayments. If they cannot do this, the lender is able to sell any of the security that was offered up by the guarantor when they originally signed onto the job. This means the guarantor could lose their own house.

Can a guarantor be removed?

When you sign up to be a guarantor, there are usually two different types.

  • Type 1: Specified In this circumstance you are only a guarantor for a specified term, as dictated in the contract. For example, when you signed on as guarantor it would have said that you are committing for X amount of years before your responsibility absolves.
  • Type 2: Continuous You are a guarantor until the mortgage is paid of or until a deed of release is signed (which would dissolve you from your duties). Usually a certain amount of equity will need to be reached in the home before the lender will release the guarantor (this could include the home increasing in value).

Can guarantors change their mind and remove themselves?

Being a guarantor is a big decision and unfortunately, if a guarantor changes their mind after the arrangements have been finalised, it is unlikely they will be able to leave their commitment. Since the loan has been granted based on the guarantor’s finances, unless the home has developed equity, in most cases the guarantor will be unable to leave the arrangement.

How do you ask someone to be a guarantor?

Being a guarantor is a big decision, and not one that should be taken lightly. When asking someone to be your guarantor, it is important to consider your relationship and them and how being guarantor might impact it. For example, what would happen to them and what would happen to your relationship if you were to default on the loan and they had to cover your payments? What if they needed to sell their house to cover the costs?

Being a guarantor is an act of good will, so you should ask someone you’re close to. At the same time, it needs to be someone who is financially secure enough to do the job. As such, guarantors are usually parents.

When asking someone to be your guarantor, it is important to make sure they understand the full breadth of their commitment, so it might be worthwhile seeking legal advice. It is also important that you have a plan in place to pay off your loan to help prevent them ever needing to step in.

What happens if a guarantor dies?

If a guarantor dies, the debt does not die with them. Instead, the guarantor’s estate can be liable. In this situation legal advice should be sought.

Can I be a guarantor twice?

Depending on the banks policies, and how much equity you have, in most cases you can only be a guarantor for one loan at a time. Once that loan has been paid off, there should be nothing stopping you being guarantor again.

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How will being a guarantor affect me?

Agreeing to be a guarantor is not a decision that should be taken on the whim. Guarantors are financially liable if the home loan holder defaults, and worse case scenario, they can lose their home if they’re unable to cover the home loan holder’s payments. On top of this, being guarantor could change how available you are for any future financial decisions such as buying an investment property. Due to this, guarantors should carefully consider any future plans they might have before putting pen to paper, as well as seek legal advice if they have any questions.

Investment property

Being a guarantor could affect your chances of being able to buy an investment property. If you are signed onto a loan as ‘guarantor’ this means that some, if not all, of the equity of your house is ‘tied up’ in the loan. Keeping this in mind, if the only way you can afford to buy an investment property is with a loan, you might not be able to do this due to not having enough equity.

Credit rating

Being guarantor poses no risk to your credit rating, provided you can meet the loan holder’s repayments if they can’t. If you both can’t meet the loan repayments, you might start to see a negative impact on your credit rating.

Selling your house

If the loan is in its early days and a significant amount of it is reliant on the equity of your home, you might not be able to sell. Unless enough of the loan has been paid off that you are able to apply to have your guarantor loan responsibilities removed, you might find yourself stuck for the time being.

Can a pensioner be a guarantor?

While most lenders prefer the guarantor to be earning an income, in some cases this will be allowed. However, since being guarantor poses you significant financial risk, if you are no longer working it’s important to fully understand what you are getting into and seek legal advice.

Words by Kathryn Lee

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