Learning how guarantor loans work is important for anyone looking to get on the property ladder if they need help to reach the minimum deposit amount.
For homeowners, guarantor loans provide them with a failsafe if they default on repayments and lessens the deposit they need to get a home loan approved when buying a property.
Getting someone else to put their financial security at risk for you can be a big ask – especially if they’re debt-free.
They’re often parents or older relatives ready to help their next of kin move on in the stage of life. Making them willing to go the extra mile in life. Even though there’s risk involved, for many older relatives the reward of seeing their children or grandchildren succeeding in life is far more important.
So with that mindset, just how do guarantor loans work?
What is a guarantor?
In lending, a guarantor acts as a failsafe for anyone who can’t make a scheduled payment. Whether buying or renting, if someone has a guarantor and they fail to pay themselves, it then falls on their guarantor to pay the scheduled payment.
A guarantor is almost always directly related to the individuals themselves. They are often a parent but can also be an older sibling or grandparent depending on the situation. Different lenders have different rules, so don’t rule out uncles, aunts and cousins completely, but they will offer you a smaller selection.
When initially making an application, the individual can nominate a chosen individual to act as a guarantor. If they miss a payment and can’t recover, the guarantor is legally obligated to make payments until the buyer can start doing it again.
How guarantor loans work
When applying for a home loan, the buyer often needs 20% to put a deposit down on the house.
If they don’t have that much, they can be liable to pay lenders’ mortgage insurance (LMI) to cover the shortfall.
However, a guarantor loan can help the buyer avoid making this LMI payment. Should someone agree to be a guarantor, it sees them put up a portion of their home to make up the rest of the amount needed to secure the full value of a home.
For example, if you are buying a home that is worth $600,000, you would need a deposit of $120,000 to reach the 20% target. If you only have $60,000, you would have to pay LMI fees to secure the rest of the amount.
Instead of doing this, the buyer can nominate a guarantor who is willing to put up a portion of their home to make up the shortfall.
This would see them put up $60,000 of equity to make up the $120,000 deposit for the property.
With a guarantor loan, the guarantors aren’t required to make payments regularly. Instead, it acts as collateral should the buyer default on a payment.
What are the benefits of a guarantor loan?
For prospective buyers, knowing how guarantor loans work provides several advantages. And it’s not just the bonus of having added security. So how does it benefit the buyer?
The LMI Factor
Saving up for any home is a timely process.
Saving up a 20% deposit could take years if you’re trying to avoid LMI. These fees act as security for lenders should you ever default and add thousands to your overall loan amount.
An alternative is to find a guarantor. Even if your deposit is under 20% (even if it’s 0%), having a guarantor sign onto your loan takes away all LMI requirements.
No guaranteed payments
For the guarantor, being included on a guarantor loan doesn’t mean you’re set for regular monthly payments.
Indeed, most of the time, you won’t have to pay anything. Instead, you act as a reserve should the actual loanee default on any payments. In most cases, guarantors can be added to the loan and never have to pay anything for its entire duration.
Most lenders allow the guarantor to come off the loan once 20% of it has been paid off, which means they’re no longer legally responsible for it.
What are the risks of a guarantor loan?
Of course, no loan comes without risks and for the guarantor, the thought of acquiring more debt can be a concern. So what should you be aware of?
That rainy day
If you are on a guarantor loan and the loanee defaults, the onus falls on the guarantor to pay the bill.
This means you’re paying for their entire payment – not just a portion of it. This will carry on until the original loanee can make regular repayments again. Should you fail to make these payments, then it does put your own home at risk as well as the home of the others attached to the initial loan.
That’s why due diligence is always advisable before agreeing to become a guarantor.
Impacts credit
By essentially taking on more debt, becoming a guarantor will impact your financial situation. Not only does it potentially add to your regular payments, it will reflect on your credit rating. This means you might not be able to borrow more money or open up any other loans if attached to a guarantor loan.
Getting help setting up a guarantor loan
In the end, knowing how guarantor loans work provides prospective buyers with an additional way of getting on the property ladder.
Not only does it help them avoid the dreaded LMI fee but it also helps them buy a house with a little less than they might have thought.
For the guarantor, their presence isn’t one where they are expected to pay.
It’s a means of supporting their kids and helping them out should things go south.
No matter what happens though, learning how guarantor loans work gives more people the chance to buy a house with their savings kept intact.
To seek out the best options for purchasing a home, speak to us at Wisebuy for guidance.
Our property experts in Newcastle NSW can give you all the advice you need to work out the best way to get on the property ladder today.
Guarantor loan FAQ
How much can guarantors provide?
In most situations, a lender will allow guarantors to cover up to 20% of the value of a home loan application. This often helps provide the prospective buyer with the least amount needed to secure the full amount needed for a loan.
How long do guarantors sit on a loan?
A guarantor will sit on a loan typically until the equity value of their home has been repaid. Once this has been met, the loanee can often refinance to remove the guarantor and be solely in the name of the actual home occupiers.
Who can be a guarantor?
In most cases, a guarantor is often the parent of the loan applicant. However, other direct family members may be considered by the lender such as a grandparent or an older sibling. It will almost always be a relation to the applicant though – not a friend or co-worker.
About the author
