How guarantor home loans work

By   |   Updated 30th November 2020

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  • Welcome to Finty's complete guide to guarantor home loans.
  • Find out who can qualify as a guarantor on an application.
  • Details on the pros and cons of being a guarantor as well as implications.

From February 2019 to February 2020 alone,median property prices in Australia rose by 6.1%. Of the country’s eight capital cities, Sydney registers the highest average property price at $872,934. With these numbers, it’s no surprise that many prospective homeowners are struggling to come up with the 20% minimum deposit to qualify for a mortgage.

Fortunately, first-time homebuyers can choose to receive additional funding from family members through a guarantor home loan. Here’s what you need to know about how a guarantor home loan works, its advantages, and its risks.

What is a guarantor home loan?

A guarantor home loan allows family members to co-sign your contract and use their own home equity as additional security for your loan. Your guarantor then becomes responsible for making monthly payments if you can’t. A guarantor can help you meet the minimum deposit or avoid Lenders Mortgage Insurance (LMI).

How much a guarantor commits to repaying is up to them – some will guarantee the entire loan or choose only to cover a portion of it.

If both you and the guarantor are unable to meet repayment deadlines, the issuing bank can take possession of their equity. They can choose to guarantee only a portion of the loan. If they repay their guaranteed amount, they are released as a guarantor and are no longer financially obligated to cover payments.

Who can qualify as a guarantor?

Virtually anyone can act as your guarantor, given that they meet the following criteria:

  • They have enough equity in their home to offer.
  • They have a stable source of income.
  • They are at least 18 years of age.
  • They are an Australian citizen or permanent resident.

In some cases, they will have to be homeowners themselves and have a sufficient credit rating.

Most lenders prefer that you designate a parent, sibling, grandparent, or other relative as guarantor. Occasionally, lenders will allow borrowers to name a close friend. Some lenders allow pensioners to apply as guarantors, though the practice isn’t common as it poses too much financial risk.

Required documents

To prove that they can pay off the loan, guarantors must submit proof of equity – such as the title or deed to their property – and possibly bank statements. Guarantors may also have to undergo a credit check.

Protections

The Australian Banking Association’s 2020 Banking Code of Practice serves to protect guarantors with a 3-day acceptance window. During this time, borrowers can seek legal advice regarding their application and review missing or incorrect information, giving guarantors plenty of time to legally back out.

In place of the borrower, a legal representative will facilitate the filling and exchange of guarantor documents to relieve pressure. Should a borrower be unable to make a repayment, it is a lender’s responsibility to inform the guarantor within 14 days.

In the event of a default, a lender will prioritise following up with a borrower before they turn to a guarantor.

Features of a guarantor home loan

Guarantor home loans are ideal for first-time homebuyers or those refinancing their mortgage but who can’t afford a down payment of at least 20%. Through this type of loan product, guarantors can commit anywhere between 5% to 100% of the loan value. Here’s how it works.

Borrowing capacity

How much you can borrow will ultimately rely on how much your lender is willing to provide. Most will lend 100% to 105% of the property value. To determine the rate, a lender will first evaluate both the borrower and guarantor’s financial health and savings record.

Even with the help of a guarantor, some banks will require that you meet a minimum deposit amount, usually from 5% to 15%.

Interest rates

Interest rates on a guarantor home loan are virtually identical to those on regular home loans. These rates can fluctuate depending on your lender and the type of home loan you’re pursuing. However, if you need Lenders Mortgage Insurance (LMI), these interest rates could potentially increase.

Lenders Mortgage Insurance

Banks will typically enforce an LMI premium on borrowers they consider high-risk – this is particularly the case if you can’t make the 20% down payment on a home. So if your loan equates to more than 80% of the property value, you may have to get LMI.

How much you pay upon settlement will depend on the size of the loan and the deposit, though some lenders will offer to finance the LMI into the home loan itself. Whether you hold a regular position with a full-time employer might also impact how much LMI you’re required to get.

Our guide to Lenders Mortgage Insurance explains everything you need to know about LMI and how it works.

Defaulting

If you default on your home loan, a lender will turn to your guarantor for the missed payment. Should your guarantor be unable to make the repayment, they could risk losing their home.

Some borrowers apply for hardship to reduce or defer repayments, especially in circumstances of illness, unemployment, or fluctuating financial circumstances. If you qualify for a hardship application, you can decrease monthly payments or extend your repayment terms without worrying about defaulting.

Alternatively, if you can’t repay the loan at all, you can opt to sell the property to protect your finances. However, banks are under no obligation to wait on a sale – you’ll want to keep them informed regularly and work towards an amicable agreement.

Features of guarantor home loans

In Australia, guarantor home loans are typically more available with larger, established banks as opposed to small-scale lenders. Offerings may vary and include the following:

Fixed & variable rate

As with a standard home loan, borrowers can select between fixed rate or variable rate terms. Fixed rate terms, where the interest rate does not change, are ideal for first-time buyers as payments remain consistent and predictable throughout the life of the loan. Fixed rate periods usually last from 1 to 5 years.

On the other hand, variable rate terms allow for more flexibility, as rates rely on market fluctuations. With a variable rate loan, borrowers can also easily switch providers without having to pay an exit fee.

Extra repayments

There are two benefits to repaying more than the expected amount. First, it’ll help build equity in your home and mean you can pay off your home loan faster. Second, it can potentially release your guarantor sooner. However, some banks may charge a fee for extra repayments. Do your research before funnelling extra money into your repayment plan.

Offset accounts

An offset account functions similarly to a regular bank account, except that its positive balance notionally decreases the home loan principal amount that’s subject to interest, potentially saving you tens of thousands of dollars over the life of the loan.

Pros & cons of a guarantor home loan

A guarantor home loan enables you to bypass some of the financial requirements of a property purchase. However, there are plenty of other monetary advantages – and risks – to consider, both as a borrower and a guarantor.

How it works to your advantage

  • You’ll enter the homebuying market sooner. If you’re new to the workforce, saving up for a home deposit can take years or, in some cases, decades. If you’re able to meet the necessary home loan repayments, having a guarantor on your side can help secure additional funds and drive you up the property ladder much faster.
  • You can avoid paying LMI. The purpose of LMI is to protect the lender if a borrower defaults, but it adds another expense to your list. A guarantor can help reduce this risk and eliminate the need for LMI altogether.
  • You can secure funds without the required 20% deposit. If your most significant obstacle to homeownership is saving up for the 20% down payment on your future property, a guarantor can help secure your application.

What you should look out for

  • Your choices are limited. Most banks only allow family members to become guarantors, which means that you’ll have fewer options to work with if your parents are unwilling or out of the country.
  • Legal action can be taken against you. If both you and your guarantor fail to repay the loan, banks will prioritise taking legal action against you before they pursue a guarantor.

The implications of a guarantor home loan for guarantors

The guarantor takes on a big share of the loan risk. Here are some of the things a financial sponsor should consider before taking on the responsibility.

General risks

Guarantors are liable for any missing repayments up to the loan amount they guarantee. If both parties default on the loan, banks can go after a guarantor’s property to make up for financial losses. Because of this, some guarantors opt to put up an investment property as collateral instead of the family home.

Impact on credit score

The act of signing up as a guarantor doesn’t itself affect your credit score. However, as with any loan product, failing to make repayments, if this becomes necessary, can negatively impact credit ratings.

Involving property

If a guarantor chooses to use their home as collateral, this can restrict their ability to purchase a new investment property. This is, in part, because all of their existing equity may be directed towards the loan they are guaranteeing.

Opting out

If a guarantor is having financial trouble, they won’t be able to opt out of the commitment until they contribute a certain level of equity. Guarantors have to remain potential active contributors for the duration of the home loan or specified term.

Alternatives to a guarantor home loan

A guarantor home loan isn’t for everyone. If you’re having trouble finding a guarantor or meeting your payments, there are still other ways to get help:

Pooled resources

Say your family member isn’t willing to go guarantor on your home loan. They can opt to pool resources for a joint home purchase instead, and establish the right ownership structure. Draft a co-ownership agreement with a solicitor, and discuss how much each family member is contributing towards the purchase price. Specify whether they are also willing to cover for insurance, administrative fees, and maintenance.

If you decide to split ownership between you and your primary contributor, you can enter a joint tenant or tenants in common contract. Under a joint tenant agreement, remaining contributors inherit the property when one of them passes away. Under a tenants in common agreement, each listed owner holds a stake in the property.

Alternatively, you can indulge in a more informal process and borrow money from a willing family member through a gifted deposit.

Gifted deposit

If you’re struggling to save up for the down payment on a costly property, consider a gifted deposit. Through this scheme, a family can contribute a portion of your deposit or shoulder the entire fee. Because a gifted deposit is not a loan there is no obligation to pay it back, and you will need to provide your lender with a gifted deposit letter stating this fact.

Our guide to home loan gifted deposits explains what they are and how they work. Well worth reading if it's something you are considering.

First Home Loan Deposit Scheme (FHLDS)

To assist first-time homebuyers, the Australian Government offers a First Home Loan Deposit Scheme. Through the FHLDS, up to 10,000 first-time property-seekers per annum can buy a home with a deposit as low as 5% – the government guarantees the remaining 15%. Since coming into effect, 1 of 10 first-time homebuyers has purchased a property through the FHLDS.

Borrowers don’t have to pay LMI and can save up to $30,000 in premiums over the life of the loan. To become eligible for the FHLDS, you’ll have to be at least 18 years old and an Australian citizen. Permanent residents are not permitted to receive FHLDS assistance.

If single, there’s a taxable income cap of $125,000 per annum to qualify for the scheme. If purchasing a home as a couple, this limit increases to $200,000.

In conclusion

Buying your first property without the appropriate savings can become overwhelming. A guarantor home loan, provided everyone is aware of the risks, can provide sufficient financial assistance and allow you to purchase a property sooner rather than later.