Guarantors & Home Loans

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 somebody 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 somebody buy a property but there are certain rules as to who can do this.

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 go as guarantor, but the 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:

  • 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
  • Until the loan is repaid in full.

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 guarantor can help?

  • You have the ability to make your loan repayments, but you have an insufficient deposit saved up to purchase a property.
  • Another 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. If you are buying a property for $400,000 and you have saved a deposit of $40,000 (10%), you need to borrow $360,000. Your LVR would be $360,000 divided by $400,000 or 90% LVR – In this instance you’ll need LMI to cover the lender’s risk of lending above 80% LVR. The borrower must cover the cost of this insurance although the policy is being taken out to cover the lender.
  • In some scenarios, a guarantor may assist with both the repayments. For example, if a borrower has saved a healthy deposit but cannot quite make the loan repayments, a guarantor can help the borrower by contributing towards the monthly repayments of the home loan. The guarantor can be released when the borrower has the ability to meet the repayments. This scenario is commonly used when parents help their child to meet the repayments until their income improves.

 What happens if 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.
On a positive note, if the borrower does exactly what they promise and keeps the loan all up to date, it can actually have a positive effect on the guarantor’s credit file. If the guarantor applies for a loan and a credit check is performed, a lender will see a financial commitment being upheld and in a state of being current, with an on-time payment history.