Guide for going guarantor

What is a guarantor loan

A guarantor on a mortgage is the person who provides the additional security for the home loan. That security comes in the form of equity in the guarantor’s own home, which is used as extra collateral to support the loan application. So by design, the guarantor will need to be a homeowner with some established equity.

Most lenders prefer the guarantor to be a close relative – usually a parent, grandparent or sibling. This is why it’s sometimes also known as a Family Home Guarantee or Family Support Guarantee or a variety of other names.

However, the guarantor doesn’t have to be a family member, but the decision on who is deemed acceptable as guarantor varies depending on the lender. The whole process is designed to make the lender feel more confident in the capacity to service the loan, so the lender will need to be convinced.

If accepted, a guarantor home loan can also be a way to avoid the cost of lenders mortgage insurance (LMI) if you’re short of the usual 20% deposit. This saving alone can be worth thousands of dollars. That doesn’t necessarily mean a zero deposit. Some lenders will insist there are some contributions by the homebuyer towards the purchase, even with a guarantor.

It’s worth noting, the guarantor isn’t required to make any payments on the loan. However, as they’re offering up the additional security, if the home buyer can no longer keep up repayments, the lender will turn to the guarantor to make those repayments. This is where the name comes from – the guarantor is ‘guaranteeing’ payments will be made. The trade off lenders make to offer a home loan when there is a small deposit.

If you’re comfortable with these risks there are a few other things to consider if you are ready to be the guarantor on a home loan for someone in your family.

Financial health for guarantors

Before you agree to be a guarantor, make a close examination of your own finances. Considering you may be called on to service the loan if the borrower is no longer able to do so, it’s important to have a good understanding of your own financial health.

There can be many disruptions to an income, such as loss of employment or a serious accident, and some types of guarantor loans hold the guarantor legally accountable to ensure the mortgage is paid off.

This is why it’s important to check whether you will be able to meet the loan repayments if the borrower can’t. Work out the total you would have to pay back, including the loan amount, interest, fees and charges. If you guarantee the total loan amount, you will be responsible for the loan amount and all the interest.

Make sure you understand the loan contract and know the risks. As you are responsible for paying back the entire loan if the borrower can’t, be sure you’re examining the loan, the finances and all the details like you would any agreement for yourself. Loans with guarantors tend to have higher interest rates, so factor this into the discussions.

An expert in the mortgage space can help you navigate these important questions.

Benefits vs risks

You’re clear on what you’re putting at stake, but what opportunities are you giving up?

It can take a long time to save for a deposit and by becoming a guarantor, you offer the borrower the chance to enter the property market sooner, and in some cases avoid costly mechanisms like Lenders Mortgage Insurance. That’s a huge advantage, especially when getting started.

However, it’s important to understand that by offering up your property as collateral, it impacts your ability to borrow for yourself. Applying for a future loan will require you to tell the lender if you’re guarantor on any other loans. That adds risk to the ability to repay, which will affect their decision to lend to you, even if the loan that you guaranteed is being repaid.

Should anything happen with the guaranteed loan, it can also impact your credit report and credit score, tools lenders use to decide whether to give you credit or lend you money.

It’s also important to consider your relationship with the borrower. You’re making a reasonable financial commitment to them so if they can’t pay back the loan or it gets in the way of your own future plans, it will impact your relationship.

You should never feel pressured to go guarantor on a loan. You are putting your own journey to wealth creation at risk and should make decisions accordingly.

Other ways to help

Considering the risks at play, there might be other ways for you to help get a family member on the property ladder.

If contributing to a deposit is an option, consider providing a little help in this way as it won’t put you, your property or future plans at risk. There are some extra hoops to jump through if a deposit includes gifted funds as they are not considered genuine savings by lenders. As a general rule, if the deposit is less than 20% of the property’s purchase price, the lender will most likely want to see five per cent of genuine savings from the borrower.

There is also the option of co-signing on a home loan between parents and children which wouldn’t require the house as a security. This can be beneficial for borrowers with limited credit history or lower scores, but it still comes with risks.

It’s also important to consider your relationship with the borrower. You’re making a reasonable financial commitment to them so if they can’t pay back the loan or it gets in the way of your own future plans, it will impact your relationship.

You should never feel pressured to go guarantor on a loan. You are putting your own journey to wealth creation at risk and should make decisions accordingly.