Guarantors and Home Loans
At NSW Mortgage Corp we answer a lot of questions about using a guarantor to take out a home loan. We decided to share some of these frequently asked questions to benefit future clients.
What is a guarantor?
A guarantor is a person who guarantees to pay for someone else’s debt if he or she defaults on a loan obligation. So it’s basically, it is someone who is willing to help you even if that means they’re accepting a little risk to do so.
Many home loan lenders out there will allow a third party (guarantor) to provide security to help someone purchase a property but there are certain rules that apply as to who can be a guarantor.
Who can be my guarantor?
A majority of lenders require your guarantor to be an ‘immediate family member’. It’s usually a parent but it can also include brothers, sisters and grandparents. A small portion of lenders will allow an ex-spouse or an extended family member’ to be a guarantor, but these requirements differ from lender to lender.
How long is a guarantor bound by this responsibility?
The guarantor must provide a guarantee to fulfil their responsibilities as long as it takes to either a) be released from this responsibility when the main applicant can prove to be sufficient to cover the loan repayments and provide the necessary amount of security to secure the loan according to the lender’s criteria; or b) until the loan is repaid in full.
Is a guarantor the same as a co-Applicant / co-signer?
No. A co-applicant (also known as co-signer) will be responsible for the loan until it is repaid in full. As per the item above, a guarantor can be released from this responsibility much sooner.
How does it actually work?
A guarantor offers up the equity in their own home or investment property to be used as additional security for the loan. The major security for the loan will of course be the property being purchased by the borrower. However, the lender will also take a mortgage over the guarantor’s property to be satisfied that the guarantee being made on behalf of the borrower is justified.
In which circumstances does having a guarantor help?
- a) You have the ability to make your loan repayments, but you have an insufficient deposit saved up to purchase a property. This can be to cover the full loan amount but certain lenders will always require some of your own equity to secure a loan – even with a guarantor.
- b) Another big benefit of having a guarantor is being able to avoid the costs associated with Lenders Mortgage Insurance (LMI). LMI is required by a majority of lenders when the ‘loan to value ratio’ (or LVR) is above 80% o the value of the property. This means, if you are buying a property for $500,000 and you have saved a deposit of $50,000 (10%), you need to borrow $450,000. Your LVR would be $450,000 divided by $500,000 or 90% LVR – you’ll need LMI to cover the lender’s risk of lending to a high-LVR applicant. The borrower must cover the cost of this insurance although the policy is being taken out to cover the lender.
How much can a guarantor guarantee?
This varies from lender to lender, but it ranges from 100% of the purchase price to as little as 20% of the loan amount.
At what stage can a guarantor be released?
The guarantor can request to be released from the loan when the borrower has built up a sufficient amount of equity in the property to secure the remaining loan amount without a guarantor. The length of time this takes depends on a few variables – the amount of deposit put into the property by the borrower, the amount of extra repayments made to the lender, and the amount of appreciation in the value of the property. Obviously, as value increases, so too does your equity, which alters the loan to value ratio (LVR).
Keep in mind that releasing a guarantor can attract some additional fees. For example, the lender may have to revalue the property to determine its value, and certain lenders have discharge fees for guarantors. Find out what your lender of choice’s policy is.
What happens to the guarantor when good intentions turn sour, and the borrower cannot cover the repayments?
The lender has the right to commence legal proceedings against the borrower. If this fails to produce a positive outcome, the lender can commence legal action against the guarantor for the amount specified in the actual guarantee of the loan. This can be the repayments, the default fee, and even the entire loan amount (depending on the guarantee). The lender usually will not have to sell the property to recover their money – the guarantor needs to treat this responsibility as if it were their own. If things do turn sour, a guarantor needs to be aware that it will affect their credit file as if they defaulted on their own loan.