What is a Guarantor, and what do they do?
A guarantor is a term used in the financial world to describe a person that promises to pay the debt of a borrower if the borrower is not able to fulfil the loan obligations. Guarantor on loan put forward their assets as collateral when the borrower is accessing a loan. In certain cases, the term guarantor is used interchangeably with the term surety.
Understanding the role of a guarantor
Certain things guide the guarantor. In Australia and with most lenders, a guarantor has to be an Australian Citizen or a permanent resident and must be above 18 years but below 65 years. This is because only a few lenders accept retirees and older people as guarantors in a mortgage deal. The guarantor needs to have a good credit history. Some lenders would look into the income of the guarantor to make sure they earn enough income to cover the loan payments in case the borrower defaults. Furthermore, if the borrower makes late payments, the guarantor might get penalised for extra interest owed.
In the Australian real estate market, having a guarantor can be the only way that allows borrowers to borrow 100% of the property value without any deposit saved. The lenders use the property the borrower is buying and the guarantor’s property as securities for the mortgage. The guarantor also has the power to limit the amount he/she guarantees.
Since banks assume that the value of the guarantee reduces the risk of the borrower, they treat the mortgage like a loan amount of 80% Loan to Value (LVR) ratio and therefore most lenders waive the requirement to pay Lender’s Mortgage Insurance (LMI). As a guarantor, you are liable for the part of the loan you agree to guarantee. If the borrower fails to meet the loan obligations and defaults, you will be responsible for the amount you initially agree to guarantee. Thus, it would help if you understood that you could be at great risk as a guarantor, depending on the number of asset-exposure you have on that mortgage.
What are the types of guarantees?
A guarantor loan helps the borrowers reach their goal of owning a house easier. However, as a guarantor, you have to understand which kind of guarantee you are going to be. When it comes to lending, in general, there are two types of mortgage guarantees.
In this case, the guarantor leverages his/her real estate properties as additional security to help the borrower access the mortgage. However, if the guarantor already has a mortgage, then the lender might take a second mortgage on the property.
Most of the time, the guarantors in this scenario are parents helping their children with the repayment of the loan. The lender usually looks into the income of the parents to work out if they can service the total loan amount and not just a portion of it.
What is a family security guarantee?
A family security guarantee is when a family member, mostly parents, use the equity in their property to help their children buy a new home. With a family guarantee loan, borrowers can buy properties without the need for a large cash deposit savings. In certain cases, the borrower doesn’t need much savings to access this type of loan.
When using a family security guarantee, you can avoid paying Lenders Mortgage Insurance (LMI) since the lender will treat your borrowing as if you are borrowing 80% of the value of the purchased property. Since you are offering more than one security (the equity in your parent’s property plus your new property), you are offered to borrow the full purchase price plus any extra fees or charges that are associated with the purchase.
The security guarantee provided by your family is limited to the guarantee amount. This means that the family guarantor is not required to pay the full loan amount to the lender, nor will they start making repayments on a new loan. Rather, if the borrower has issues with the loan repayment and it gets to a stage where the lender needs to recover the funds, the lender can and has the right to recover the guarantee amount from the guarantor.
A mortgage is established on the guarantor’s property as part of the guarantee loan process. Hence, limiting the options your parents would have if they were planning to sell their property. However, if parents are considering releasing equity for other acquisitions or helping siblings buy their own properties, it can be possible. All of this depends on the lender’s policy at the time of the mortgage agreement.
What are the eligibility requirements to be a guarantor?
When selecting a guarantor, you need to choose someone whom you can trust and someone who trusts you in return. Most borrowers turn to their family members, friends, or business associates when selecting a guarantor. However, a guarantor must satisfy certain requirements before a lender can approve them as a guarantor.
The guarantor eligibility requirements include but not limited to;
- Must be an Australian citizen or be an Australian permanent resident
- Have a good personal credit history
- Have a stable income and equity in their property
- Be above 18 years and not more than 65 as most lenders don’t accept retirees or older people as guarantors.
Who can be a guarantor?
A guarantor is a great way to help a friend or family member purchase their home sooner therefore in most cases, guarantors are limited to immediate family members, friends, or business associates. Usually, the guarantors are parents but can also be grandparents or siblings. Some lenders approve extended family members and also ex-spouses to serve as guarantors to a loan. However, “who can be your guarantor?” depends mostly on the choice of the lender.
How do Guarantor Loans work?
Guarantor loan requirements
There are certain guarantor obligations and guarantor requirements needed before you can access this type of loan. They include:
- The guarantor age must be over 18 years and in some cases guarantor age limit will be 65 years old
- Must have enough equity in the property
- Some lenders may ask for the guarantor to have a stable source of income
- Must be an Australian citizen or be a permanent resident of Australia
- Must have excellent personal credit ratings. As such, the lender will like to see a credit check is done on the guarantor to confirm their credit standing.
- The guarantor needs to provide documents showing that they can pay off the loan, or the amount they guarantee. Some of the accepted documents can include proof of equity and bank statements.
Will a guarantor home loan cost more?
The guarantor home loans could cost more compare to a loan with deposit. It may have some fees and charges associated with it. When you use a guarantor loan to avoid paying LMI instead of saving up a deposit, then the mortgage could end up costing you more in the end. The main reason is due to paying interest on a higher amount of loan compared to say, a 20% deposit with a loan of 80% LVR.
What if my parents have an existing mortgage on their house?
Your parents can still serve as your guarantors even if they have a home loan, as long as they have sufficient equity. Some lenders can still obtain a guarantee on their properties using a second mortgage. However, keep in mind, the guarantor needs to declare all the loans on their property. The loans may include both commercial and residential loans. Failure to declare the existing loans might lead to rejection of your application before settlement.
Are you able to sell your house if you are a guarantor?
As a guarantor, you should understand the risks you are assuming when you agree to help someone buy a home. Thus, before you sign the guarantor agreement, keep in mind that you might not be able to sell your property or access a mortgage on it. Essentially it may mean that you may have to delay your goals of selling your property as it may not be possible as long as you are a guarantor.
To be able to release the guarantor, if your current loan balance is over 80% LVR (loan to value ratio), find out if you can raise your savings to cover the remaining funds to bring the loan balance to 80% LVR. Alternatively, you contact Blutin Finance – mortgage broker Melbourne and we can order valuation from different lenders to find out the value of your property and ultimately working out the right LVR.
In general, with some lenders, you can replace your guarantee with the same amount in a term deposit. This means that if your guarantee was $300,000 then you will have to give the lender $300,000 term deposit that they can hold as security. You will still be accumulating interest on the term deposit whilst providing the guarantee. If you determine that you can achieve that, then you can go ahead and sell your property.
What if my parents are retired?
The age requirement for serving as a guarantor is between 18 and 65. This is because most Australian banks may not accept a security guarantee from the elderly or retired guarantor. The retired guarantors no longer have a stable source of income that is needed to play the role.
However, not every lender assesses guarantors with that criteria. Some of our lenders can accept guarantors that are retired, pensioners, or other self-funded retirees over 65 years. As long as the retired parents seek independent legal advice before signing the loan offer, some of our lenders may allow them to serve as guarantors.
What are the benefits of Guarantor Loan for buyers?
Guarantor loans offer various benefits to the borrowers, depending on your financial goals and current circumstances. With a guarantor loan, you can enjoy some benefits such as;
- Avoid paying the Lender’s Mortgage Insurance (LMI): a key benefit of obtaining a guarantor on your home loan is that it might help you avoid paying the LMI. The lender’s mortgage insurance is a one-off premium fee that you will pay to the lender. The fee is to help protect the lender against financial losses in case you are unable to meet the mortgage repayment requirements. Banks and lenders generally require the borrowers to pay the lender’s mortgage insurance on loans where the borrower cannot put in a deposit of at least 20% of the property’s value.
- The guarantor loan allows you to buy a property as soon as possible since you don’t need a deposit
- Gives you access to the property market faster
- Allow you to access better loans that come with more favourable rates
- It also helps consolidate minor debts like the credit cards when you purchase a property under this loan type
Who is a guarantor mortgage suitable for?
The guarantor home loan is not designed for all types of borrowers. It is most suitable for the following set of borrowers;
- Borrowers with a low income (in case of income guarantor)
- Borrowers with weak credit score
- Borrowers with zero or little deposit. These are usually first-time buyers
How much can I borrow?
The guarantor loan can help especially the first-time buyers and people with poor credit scores to access a mortgage. Hence, with the guarantor loans, you can borrow up to 100% of the property purchase price or even slightly higher. Some lenders on the panel with Blutin Finance allow you to borrow up to 105% of the purchase price of a property. Although some of the lenders will only hand out 100% of the property value as a mortgage in case of refinancing. The extra sum will help you cover for the expenses that come with buying and moving into a new home.
Specifically, the amount you can borrow with the help of a guarantor largely depends on the purpose of taking the mortgage. Most lenders give;
- 105% of the total cost of construction and land value for people that wish to build a home
- 100% of the property value for refinancing purposes
- 110% of the house value for debt consolidation and purchase of a property
- 105% when it comes to property investment purchase
Ideally, there is no maximum size for the mortgage you can access. However, most lenders require you to meet additional credit criteria if you wish to borrow over $1 million.
What are some of the risks for the Guarantor?
Guarantor loans can be risky for the guarantors. This is because the guarantor will be liable when the borrower fails to make the repayments. They stand a chance to lose their property completely when the borrower fails to meet their obligations and make repayments.
In situations where guarantors don’t have the savings to pay for the debt, they may have to apply for a second mortgage on their property or get a second loan. If these avenues have been exhausted, the bank or lender doesn’t have a choice than to sell the guarantor’s property and take enough of the money to cover the guaranteed amount. The remaining funds from the sale of the property will be returned to the guarantor. As the guarantors are only liable to pay the amount they agreed to guarantee, once they pay that amount, they are no longer bound to any further liabilities.
Should I act as a guarantor?
You shouldn’t act as a guarantor if you don’t want to. Choosing to become a guarantor is a big decision. Hence, you need to seek independent legal and financial advice before you decide to be a guarantor. You should also ask yourself a few questions to determine where you stand.
- Is the limited guarantee too much for you to cover, or can you cover it with ease?
- What are the set conditions that would make you liable to pay?
- Do you attest to the character of the person you are standing for?
If you don’t want to serve as a guarantor but wish to help your child get their home, you may wish to consider other ways of helping such as cash gifting or loan.
When can I remove the guarantee?
There are certain conditions that you should meet before you can apply to remove the guarantee on a mortgage. Some of the conditions include:
- The borrower affording to repay without needing help (in case of income guarantor)
- The balance of the mortgage is equal or below 80% of the property value (without paying the LMI)
- The borrower hasn’t missed any payment in six months
After any of these conditions are met, the guarantor can apply to remove the guarantee. Furthermore, the borrower can apply to remove the guarantor if he meets the conditions.
Are there other protections for guarantors?
Yes, there are. According to the Australian Code of Banking Practice (COBP), guarantors can enjoy the following protection:
- They will be given at least three days to review the guarantee papers and to consider their duties as guarantors before agreeing to the role and returning the documents
- They will be given cooling-off period once they sign the agreement
- They will be asked to seek independent legal counsel before signing
- The bank or lender will notify the guarantor if the borrower gets into any financial difficulty or if the circumstances change for the worst
- The bank has to start collecting assets from the borrower before moving to the guarantors during this process.
Do I need expert advice if I’m a guarantor?
It is recommended to consult an expert mortgage broker when you become a guarantor. This is because there are several things to consider when applying for this type of loan. Seeking expert advice, especially from Blutin Finance, will make it easy to access the lenders and help you stay within your liability limit. Furthermore, Blutin Finance will help you if and when you decide to remove the guarantee.
Apart from speaking with a mortgage broker, we highly recommend seeking advice from an independent solicitor and financial planner. In some circumstances, getting advice is mandatory.
Example of a Guarantor loan
Michael has been living on his own for a few years now and feels the time is right to buy his home as he gets ready to have a family. He finds an exquisite three-bedroom house in a nice neighbourhood. The property is worth around $700,000, and he knows that if he doesn’t act fast, he will likely miss out on the house to someone else. However, the stumbling block is that he doesn’t have enough savings to cover the deposit that would qualify him to get a home loan due to the monthly rents he pays. He needs to come up with 20% of the property purchase value before he can qualify for a mortgage.
His parents decide to come and help. They are both working and their house is paid off. This makes them qualified to serve as his guarantors. The parents agree to serve as guarantors and offer their house as security to access the loan.
Michael can receive 105% of the purchase price of the property to cover the mortgage and other expenses such as stamp duty and conveyancing fees. Since it is a guarantor loan, Michael doesn’t have to pay the Lenders Mortgage Insurance (LMI), a one-off premium he would have paid.
How will having a guarantor help your loan application?
A guarantor will help your loan application by:
- Ensuring that you buy your house immediately since you don’t need a deposit to access the loan
- Get discount interest rates from most banks and lenders similar to the borrowing of 80% LVR
- Save money by avoiding the LMI premium
- And limit the size of the guarantee
Are there any other ways my family could assist me to buy a house?
If your parents don’t feel comfortable being your guarantors or you feel that the guarantor home loan doesn’t seem right for them, there are other ways your family can help you.
- Your family can help give you money to help towards your deposit. You can pay them back according to any agreement you have with them.
- They can let you move back in with them to reduce your expenses. At home, you don’t have to worry about rent and bills, which would help you boost your savings towards a deposit.
- Your family can co-sign a loan with you and become a co-owner of the property. This means that they will own the property as well as share the loan repayment responsibilities with you without putting their house as collateral.
- They can gift you part or all the deposit you need.
What happens if your guarantor dies?
If your guarantor dies, the debt doesn’t end with them. The estate of the guarantor will remain liable for the debt.