What is a guarantor home loan?
A guarantor home loan sees a family member promise a bank they will meet the terms of the loan contract if a borrower fails to do so. This is more than a “handshake” agreement. It will involve the guarantor handing over property or cash as extra security in addition to signing a legal contract called a deed of guarantee.
While guarantor loans are common in both business and home lending. We will deal with how a guarantor home loan can help a family member onto the property ladder when they have little or no deposit.
Guarantor home loans make a couple of things possible:
- They can put the borrowers in a position to buy a home when they could not have done it without them.
- They can significantly improve the lending terms for a borrower. This can see borrowers with small deposits get a home loan with lower rates and costs – like avoiding LMI.
How does a guarantor home loan work?
A suitable guarantor can help a family member purchase a home when they have little or no savings.
Saving enough deposit for a home is hard. It has long been gold-standard to save 20% of your purchase price. What many buyers do not realise is that they also need to pay for the purchase costs too—so it is really 20% plus costs. This becomes next-level difficult if house prices are constantly moving north.
Parents often have what kids do not—property and cash.
Banks are in the business of lending and part of this is considering their risk position. If a buyer cannot come up with the ideal 20% deposit for a house purchase, banks can look at other ways to secure the loan in lieu of a cash deposit.
They need some skin in the game from the borrower or guarantor—this is where family comes in.
What do guarantors offer the lender?
In a parent (guarantors) and kids (borrower) scenario, the kids will often have little or no deposit.
Parents often have what kids do not—property and cash. Guarantor home loans make use of these assets to help secure the home loan for the kids.
Guarantor home loans are about giving a bank the security they need to advance the loan. The bank will obviously take the property being purchased as security but when the cash deposit is small, they will also look for additional security. There are two common options for guarantors to offer the bank extra security:
Property
Guarantors can offer the bank a property they already own as the extra security. The property needs equity built up (it can even have a loan against it) and the bank uses the equity as the extra piece of security they need. Contracts should define the amount of the guarantee which limits the amount the guarantors promise to cover.
Cash
If they have cash saved up in a term deposit, they could use this as the extra security the bank needs to approve the loan.
Calculating the guarantee
I have used an example purchase scenario below to show the generally accepted method for calculating how much of a guarantee is needed.
In this example the guarantors will need to provide extra security of $110,000 because of the small deposit (less than 20%) available.
A guarantee is not a gift of cash.
A guarantor is not a borrower.
Guarantors are not responsible for the home loan repayments—just the amount they have guaranteed if called upon.
So, the bank now has two pieces of security:
- The home the kids are buying.
- Guarantors (often parents) cash or property to meet any deposit shortfall.
The amount of this guarantee should be defined in any loan contract. Even if parents offer a property that is worth $800,000 the amount of the guarantee should still be limited to $110,000. Without getting too legal there is usually a provision for a bank to claim this amount plus any costs associated with it.
Guarantor home loan structure
Getting the guarantor home loan structure correct is essential in protecting the guarantors from being over-exposed.
The illustration below shows how a guarantor home loan can be structured. Importantly, it shows parents helping kids only to the extent needed—to secure a shortfall only.
In my mortgage broking experience, I used this structure for borrowers and guarantors as it limited exposure of the guarantor. In this case keeping exposure to $110,000 and not the full $590,000.
How much can you borrow with a guarantor home loan?
Some banks allow you to borrow the full purchase price plus associated costs if you have enough guarantor support. Banks can put a limit on costs they will finance but most products are designed to absorb costs of typical transactions.
A borrower does not always need a deposit.
In theory, a borrower does not need a deposit and could also borrow the costs for the purchase. Here is an example of how a guarantor can help a borrower with no deposit.
This example shows how a borrower could buy the same property as previous (purchase price $600,000) without a deposit. Without a deposit the borrower would need a home loan to cover the purchased price as well as costs being $630,000. The guarantor home loan amount would be $150,000 in this example given there is no deposit contribution from the borrower.
Can you borrow more with a guarantor home loan?
In short—YES and NO.
The banks need to test a borrower on two broad levels:
Can they afford the loan they want?
The lending rules require a bank to make sure they lend in a responsible manner. This rule remains consistent whether borrowers have big or small deposits.
Is the bank’s position secure enough?
Banks also need to ensure they do not end up in a risky position. Most banks standards have settled on a 20% deposit being the gold-standard. Low deposit home loans of 10% or even 5% are possible but considered riskier and can attract higher fees and rates.
So,
YES, you can borrow more
Given savings need to cover both deposit and costs then a guarantor home loan allows you to borrow what you can afford without being limited by your deposit amount.
NO, you cannot borrow more
If you are at your borrowing limit based on your financial position (income vs expenses), a guarantor will not help you borrow any more. Remember—Guarantor home loans see family provide security only. They are not undertaking to help pay your loan each month.
Who can be guarantor for a home loan?
Guarantor home loans in Australia are a way for family members to help each other out. It is usually parents helping kids but can also be siblings depending on bank policy.
Characteristics of preferred guarantors
- Family member – Parents and siblings most commonly.
- Guarantors can be working or retired. If they are retired, it is preferred that a government pension is not their only income.
- Significant equity in home or investment property. Generally, checks are made so that guarantors are not exposed over 70% (their loans plus any guarantees).
Or….
Lots of cash savings. These might be in term deposits. - Guarantors are keeping up with their own debt obligations.
- A key test can be for the guarantors to ask themselves if this all comes crashing down will they lose their home?
Sure, it will not be pretty, they might need to pay off the guarantee or dip into superannuation if accessible or sell an investment – but will they be able to keep a roof over their heads?
If so – and they understand the risks- then they are likely suited to offering a guarantee.
Below is an example of how the guarantors own home loan position needs to be considered before approving a guarantor home loan. Their own lending commitments are included when assessing their overall property exposure. Under 70% LVR is usually considered acceptable.
Pros and cons
Borrower PROS
- Can buy without waiting. No more saving. Deposit is no longer the limiting factor.
- Save on fees– could save on significantly risk fees charged to borrowers with low deposits. One common and significant fee is Lenders Mortgage Insurance (LMI).
- Lower interest rates – Loan rates are generally lower the stronger your position is. While you might not have a big deposit you will be considered a low-risk client because of the guarantor home loan structure.
Borrower CONS
- Family might be a little more interested in your future financial decisions. Might comment on your spending choices. Should you go on a luxury holiday when they are still on the hook for your loan?
- Making future changes to loan could involve consents from the guarantor.
- Given the higher borrowing ratios borrowers are at risk of owing more than their home is worth if the property value decreases.
Guarantor PROS
- You can help kids without giving them or loaning them cash.
- Any property offered to guarantee a home loan is still yours. Banks specify the amount they need for the guarantor home loan.
- Any cash savings you have placed in an account to guarantee the home loan is still yours. While it will not be accessible during the period of the guarantee, you will still be able to earn interest if it is an interest-bearing account like a term deposit.
Guarantor CONS
- Need to prepare for a medium-term commitment. Think years not months. It may affect your personal borrowing needs.
- Less flexibility with selling property or using cash. Not impossible but there are limitations.
- In the event the guarantor is called upon to pay down the guaranteed portion of the home loan, they might be forced to sell their home to clear any debt. This is in the event that there are no other preferred strategies employed to pay off the guaranteed portion of the loan amount.
How to remove a guarantor
The spirit of a guarantor home loan is never a permanent arrangement. It is a stepping-stone to owning a property on your own terms and not relying on anyone else. Just you – oh, and maybe the bank.
There are a few ways to remove a guarantor.
Guarantor support is no longer needed once you can demonstrate there is enough equity in your home to no longer need a guarantor.
Put simply, the release of a guarantor relies on both the property value going up and loan amount going down.
Here are three common ways to remove a Guarantor from your home loan.
Property Increases in Value
Over the first few years, borrowers may see their home improve in value while also seeing some principal paid down off their home loan.
When borrowers can show that their loans are below an acceptable ratio to the home value (generally accepted loan to value ratio is 80%), most banks will allow the removal of the guarantor from any home loan obligations. This is something that will need to be initiated by the customer.
Banks are usually happy to oblige by performing a new valuation.
By way of example, if the above property goes up to $700,000 then the gold-standard 80% benchmark is now $560,000. The original loan was $590,000. If at the time of the valuation the loan has been paid down to $560000 or less the guarantors could be removed.
Keep your eye on the sales market and if recent sales indicate your property has increased in value, then you can contact your bank or mortgage broker to take steps to remove your guarantor from your home loan.
Some borrowers remain at the same bank, others take the opportunity to refinance to another bank based on their improved equity position.
Loan is Paid Down
Some structures can provide a separate “guaranteed loan portion”. Loan contracts make it clear that when $110,000 has been paid off and the loan closed, the guarantee that was helping to secure this loan can be released. A good strategy I have seen is where borrowers focus most of the home loan repayment efforts towards the guaranteed portion.
This is a helpful structure that does not rely on property values at all.
Refinance
Borrowers reapply and demonstrate some equity – maybe not 80% LVR but some (say 10%) might demonstrate enough to release the guarantor and borrowers pay fees.
Say you initially had a 10% deposit and used a guarantor home loan to reduce fees and get better loan terms you might find that in time you can demonstrate 20% equity – and so release the guarantee.
Perhaps you had 0% deposit initially you might be happy to release a guarantee when you can show you have 10% equity. This might involve significant fees because the equity is not 20% but – the guarantor home loan got you started and now you can do things on you own terms.
The options for removing a guarantor could see you refinance and move banks or renegotiate new terms with your current bank.
Do all banks offer a guarantor home loan?
Not all banks can offer a guarantor home loan. Of those that do, not all can take cash as the extra guarantor security. Property is the main security considered for a guarantee.
A mortgage broker can help navigate the various options including any government guarantee options.
Considerations
A few banks offer this product but will differ in how they structure the loan. You can deal directly with a bank or discuss your options with a mortgage broker.
Given the legally binding arrangement required for a guarantor home loan it is wise and often obligatory for guarantors to get legal advice before agreeing to a be a guarantor.
Final word
A guarantor home loan can be a way for family to help you onto the property ladder. It enables home ownership sooner, in an era where saving a deposit is difficult for many.
