One of the hardest parts of buying a property can be saving the deposit. A guarantor home loan could give buyers the chance to enter the market years ahead of schedule by using a guarantor (generally a parent or close relative) to cover some or all of the deposit. As a result, buyers could potentially qualify for a home loan with cash savings equivalent to just 5% of the purchase price or even 0%.
What is a guarantor home loan?
A guarantor home loan is when property is purchased using someone else’s (a guarantor’s) assets as security. Guarantors contribute to the deposit not by paying cash but by using the equity in their property as security.
So, potentially, the buyer might make a 5% cash contribution and the guarantor a 15% equity contribution, for a combined 20% deposit; or in some cases the buyer might make a 0% cash contribution and the guarantor a 20% equity contribution. As a result, the buyer would be able to qualify for a home loan and would also avoid paying lenders mortgage insurance (which is generally charged when a borrower has less than a 20% deposit).
Requirements to be guarantor of a home loan
Many lenders will only accept guarantors who have a strong relationship with the buyer, such as a parent or guardian. They will also look at your credit history and ability to repay the loan should the buyer default.
For someone to act as a guarantor, they need to own a property and that property needs to have sufficient equity. So, as part of the process, the lender will conduct a valuation of the guarantor’s property.
The guarantor also needs to accept legal responsibility for the repayment of the loan. In other words, if the buyer fails to keep up with their mortgage repayments, the lender may chase the guarantor for payment; it’s even possible the lender may seize and sell the guarantor’s property to recoup its debt.
But that doesn’t mean the guarantor needs to be tied to the mortgage for the entire loan term. After a few years, once the buyer has built 20% equity in the property (potentially through a combination of paying down some of the mortgage and having the home rise in value), the buyer can refinance and remove the guarantor from the loan contract. Also, some guarantor loans can be set up as two loans, with the guarantor’s property used as security to cover only a percentage of the total amount borrowed (usually to cover the deposit).
Guarantors should proceed with caution
Acting as a guarantor, therefore, involves risk, which is why guarantors should get legal advice before proceeding. It’s important that both parties – buyer and guarantor – have a clear understanding of their responsibilities under the arrangement, to avoid a breakdown in the relationship.
Guarantors should also understand that their borrowing power will be reduced for as long as they’re tied to the mortgage, because lenders will have to factor in the possibility that the guarantor may be forced to cover the buyer’s mortgage repayments.
Alternative options
It’s important to note that being a guarantor is not for everybody and it’s certainly not the only solution that can be effective in helping people to enter the property market without a 20% deposit. Some of these other options include the buyers paying lenders mortgage insurance or applying for any government schemes that may be available.
As you can see, guarantor home loans can be a wonderful finance solution, but are not suitable for everyone. Reach out to your Loan Market broker if you would like to review your investment home loan.
