What is a guarantor home loan?

A guarantor loan may help a prospective home buyer secure a property even with a smaller deposit. But there are a few things you may want to consider before you ask a loved one to be guarantor on your home loan.

A guarantor is a family member (usually a parent) who uses their equity, typically in their property, as security for part or all of your mortgage. You still are borrowing money from a lender, and will need to pay back the principal and interest, but a guarantor provides security for the loan.

When lenders assess home loan applications, they want to see proof that you can service the loan, or pay it back. The lender will consider your financial position by assessing your savings, income, expenses and credit history to determine how much money they are willing to lend you.

For a lender, a guarantor adds a level of security if you were unable to pay back the loan yourself.

Essentially the guarantor agrees to offer part or all of their equity to act as a backup should the primary borrower not be able to meet their repayments in the future, reducing the size of home deposit required. This can potentially help first home buyers to avoid Lenders Mortgage Insurance (LMI) and purchase a place of their own far sooner.

There are two main functions of a guarantor home loan. Firstly, a guarantor on a mortgage acts as security for the home loan repayments and proves to the lender that the repayments will be met either from the borrower or the guarantor.

This means if you are unable to meet your loan repayments, the guarantor is promising they will absorb the responsibility. If they fail to do so, they face the risk of the lender repossessing their property or having to sell their home to meet the repayments.

Another function of a guarantor home loan is that a guarantor on a mortgage may allow a borrower to take out a loan with a smaller deposit, getting them into the property market sooner.

In many cases a 20 per cent deposit is required to secure a home loan without paying lenders mortgage insurance (LMI). For example, a $500,000 property would require you to have $100,000 in genuine savings. This represents a loan-to-value ratio (LVR) of 80 per cent, meaning you are borrowing 80 per cent of the property's value.

With a guarantor, however, the lender may consider lending you more than 80 per cent, with your guarantor’s equity acting as the deposit. And, in some rare cases, lenders may allow you to borrow up to 100 per cent of the value of the property if you’re using a guarantor,

However this is heavily dependent on your financial circumstances which will be assessed as a part of the application with the lender. Most lenders will require you to put down a deposit of some kind, even if you have a guarantor with strong equity in their property.

A guarantor loan is when a relative or family member (usually a parent) uses the equity in their property as security for your mortgage. You still need to borrow money from a lender and repay it, but your guarantor provides security for the loan in the form of equity that you would normally have provided in the form of a deposit.

Equity is the difference between how much a property is worth, and how much is owing on the mortgage.

For example: A property was purchased 20 years ago for $500,000 with a 20 per cent deposit ($100,000). This means $400,000 was owed to the lender. 20 years later, the property owner has paid off $250,000 of their mortgage, and has $150,000 remaining. During the twenty years the property's value has increased to $950,000.

In this circumstance, the owner now has $800,000 in equity; $950,000 is the value of the property and $150,000 is still owed to the lender. If this was a parent or relative, they could potentially use a portion of that equity as security on your home loan.

In some circumstances, using a guarantor may allow you to borrow more money. However, this depends on the financial circumstances of you and the guarantor, and what level of risk the lender is willing to take on.

Some lenders may require a guarantor to be a close family member, such as a parent or partner. Despite parents being the most common guarantor, some lenders may also allow other relatives to be guarantors, like a grandparent, sibling, aunt or uncle.

The term ‘Bank of mum and dad’ often refers to home buyers who may have their parents act as guarantor on their home loan, or who may provide their children support to get a home in other ways such as by contributing towards their home loan deposit.

Lenders will have different eligibility requirements of who can be guarantor, but the following may apply:

Secure income

Just as it is assessed for the primary borrower, lenders will assess the guarantor’s income and might ask for proof of annual pre-tax salary.

If the guarantor is a sole trader, or self-employed, the lender may require more income information such as two years of tax returns, profit and loss statements from their business and proof their ABN has been registered for two or more years.

Strong credit score

A credit score is a number that helps to represent the trustworthiness of a borrower based on their history of borrowing. Lenders will generally look at this score before lending money, to help determine the risk involved in lending to an individual.

Borrowers who have made repayments on time on other loans like their car, credit cards or personal loans may have a stronger credit score.

For guarantors, having a strong credit score could reinforce to the lender that in the event the repayments fall to them, they will meet the repayments.

Sufficient equity in their home

Guarantors may need to have a high amount of equity in their home, for example a lender may prefer at least 80 per cent equity in the home of the guarantor, meaning they only owe 20 per cent of the value of their property.

The property they are using equity for security from also may also need to be in Australia, but check with your lender if this is a requirement.

Getting a foot on the property ladder faster

For some borrowers, having a guarantor can fast-track their path into home ownership because it may be quicker than the time it would take to save up a sizeable deposit.

Having a guarantor may strengthen your home loan application as it shows the lender you have security in place for the loan. But it’s important to remember that lenders will still want you to demonstrate you’ll be able to repay the home loan in your own right.

Avoid paying LMI

LMI can add thousands onto your home loan. You may deem it to be worth the cost if property prices are increasing faster than your ability to save, but using a guarantor may allow you to avoid paying LMI altogether.

That’s because the risk to the lender has already been insured in a different way by having the guarantor’s home act as security for the home loan.

There are other ways to avoid paying LMI, such as by qualifying for certain LMI discounts and deals that may be available from some home loan lenders, or by securing support from the First Home Guarantee scheme.

Guarantor’s property risk

Before a guarantor agrees to provide security for a home loan, it’s vital they understand the risk of having to sell their property or have it repossessed.

In the event the primary borrower cannot make their repayments the guarantor is then liable to cover the repayments. If the guarantor also can’t make the repayments, they may be forced to sell their home to repay the loan.

Credit score

In the event the guarantor becomes responsible for the loan repayments, they are essentially taking on a mortgage. Guarantors may have their own mortgage already, or other life expenses.

In the event they miss repayments or fail to meet them, their credit score may also be impacted.

Impact on relationships

Asking a family member to be a guarantor is a financial commitment which may put strain on the relationship. A traditional home loan can be 30 years long, meaning you are entering into a loan not only with a lender, but the guarantor will be linked to that mortgage for a period of time while they wait for your equity to increase.

It can be important to seek independent financial advice before committing to becoming a guarantor.