Using a guarantor to purchase property
First-time buyers sometimes seek financial help from others to help fund the purchase of their first house or apartment. It’s a great way to fast track your way into home ownership. But whether it’s parents, other relatives, or close friends, guarantors carry risks.
Whether you’re trying to enter the market, or you’re an established owner who’d like to help the younger people in your life get a leg up onto the property ladder, it’s worth understanding the risks and rewards…
If you don’t have the standard 20% – or even 10 or 15% – deposit for a home loan, there are a number of ways to obtain the credit you need to secure a home loan. The most common are known as family pledges and there are two types available to borrowers: servicing guarantees and security guarantees.
Servicing guarantees explained
Servicing guarantees are more or less a thing of the past. Lenders used to allow a family member to guarantee all the repayments on the loan being applied for, but this placed a huge burden on the guarantor who could have found themselves stuck paying the repayments, if the borrower became unable to pay.
Lenders may still consider a servicing guarantee, on a case-by-case basis, but it is usually our recommendation this type of guarantee is not often in the best interests of the guarantor. We prefer our clients can comfortably afford the loan repayments on their own.
Security guarantees explained
A more popular option is a security guarantee. Borrowers who have a limited deposit often use this approach to minimise the upfront cost of lenders’ mortgage insurance and possibly higher interest rates too.
In this situation, a parent uses the equity in their property to guarantee the deposit of the borrower. It is preferred the guarantor offers an investment property instead of their home but guarantees using the residence can be taken as collateral if it is safe for the guarantor.
For example, for a purchase price of $600,000, in a security guarantor situation the borrower might take on the debt of 80% of the value of their loan, which would be $480,000, in their own name and secured against the property they are buying.
The loan for the balance, $120,000 + approximately 6% of the purchase price to cover the stamp duty etc, is then secured against the guarantors’ property. This second loan is still in the names of the borrowers, but the guarantor’s property is at risk if repayments fall behind.
Lenders often choose to approve one loan for the entire amount required but, here at Mortgage Broker Melbourne, we like to separate the 2 amounts so the borrowers can track the guaranteed loan, so they can target extra repayments toward that to release the guarantor at the earliest possible time.
A leg up
Using a guarantor is a very popular way for first home buyers to enter the property market. It’s especially effective when the borrowers don’t have a substantial deposit, but their parents own their own home. A 20% deposit means borrowers can access better loan deals and can avoid paying Lenders Mortgage Insurance too. As long as the guarantors are comfortable with the borrower’s ability to pay back the loan, it’s an effective way to purchase property faster.
A note of warning
Sadly, marriage breakdowns, death and financial hardship (from both borrowers and guarantors) can happen unexpectedly, and can seriously impact a loan guarantee arrangement. Make sure you seek professional advice and have written agreements covering these unforeseen circumstances.
Guarantors are required to seek independent legal advice before entering into a guarantee.
To find a solution that will help you own your own home sooner, speak to an expert at Mortgage Broker Melbourne. We are MFAA-accredited, and offer our services at no cost to you. We can help you navigate the home loan market and find the best deal for your circumstances.
Marc has been a professional lender for 28 years. After beginning his career in 1990 with a UK Building Society, he moved to Australia where he held several different retail banking roles. In 1999 it became clear to him that a mortgage broker would eventually become an obvious choice for someone looking for a home loan so he took the plunge and became an independent broker. He hasn’t looked back since!