Going guarantor on a home loan

A guarantor home loan is a type of home loan where someone, usually a family member, acts as your guarantor by offering a portion of their existing home equity as security against your home loan – usually to help you get approved for the loan in question.

This equity acts as an additional security guarantee against potential borrower defaults on your part, and as a guarantee to the lender that your home loan repayments will be made one way or another. It can also be used to improve your loan-to-value ratio (LVR), which can help you avoid paying lender’s mortgage insurance (LMI).

As the guarantor will typically be offering up sufficient equity to secure the loan, no cash needs to exchange hands between the guarantor and your lender. However, if you default on your home loan and are unable to meet your home loan repayments, the guarantor will assume responsibility for paying off the entire loan.

Depending on your loan amount and the amount of equity the guarantor offered as security against it, a home loan default on your part could see your guarantor’s property sold to pay off your own home loan. Naturally, this could put a major dent in your guarantor’s file, to say nothing of the damage it could do to your own credit score, financial situation and potentially your relationship with your guarantor.

To give you a better idea of how a guarantor arrangement might work, let’s look at an example.

Sarah wants to buy a property worth $400,000 and has 5% of the purchase price ($20,000) in genuine savings, but she needs a 20% deposit ($80,000) to avoid paying LMI. To cover the difference, she asks her parents to be her guarantor and offer up enough equity to help guarantee her home loan.

Sarah’s parents agree to stump up $60,000 in equity, which helps Sarah secure her home loan without having to pay LMI. While this agreement has saved Sarah thousands in LMI costs and helped her become a homeowner, it has also left her parents at financial risk should Sarah default on her home loan repayments.

If you’re a first home buyer or have only a low deposit amount saved, a guarantor could potentially help you get approved for a home loan. It could also help you avoid paying LMI or reduce your LVR enough to lock in a more favourable interest rate.

However, be sure to thoroughly assess and discuss the risks of a guarantor home loan with the person you’d be asking to be your guarantor. The financial risks that come with this type of loan are significant, and you’ll want to make sure your potential guarantor understands them fully before they commit to the agreement. The lender will typically insist that the guarantor seeks independent legal advice before making a final decision regarding the arrangement.

Yes, you can usually refinance to a new home loan from a guarantor home loan – if you meet your bank’s lending criteria for refinancing to the new loan. If you’re still not eligible for a regular home loan, you won’t be able to refinance your guarantor home loan just yet.

Depending on your lender and the home loan products they offer, you may be able to take out an investment loan with the help of a guarantor. However, you’ll have to enquire with your mortgage broker or the lender to discern what kind of investment home loans options they have available to a prospective borrower with a guarantor in tow.

Here’s a summary of the main pros and cons that come with a guarantor home loan:

Lenders will generally require a home loan guarantor to be an individual, such as the borrower’s spouse or an immediate family member. A guarantor loan’s requirements may allow for a company to act as a guarantor, but in most cases a home loan guarantor will be an individual close to the borrower, which plays a large part in their riskiness – defaulting on a regular home loan only affects you and your own property, whereas if you as the borrower default on a guarantor home loan, that affects you and your guarantor family member.

Furthermore, in a worst-case scenario where the guarantor can’t cover your outstanding payments, the lender has the right to sell either your own home or your guarantor’s home to cover the debt, or even both if necessary.

Agreeing to be a home loan guarantor for someone could potentially affect your credit score in two different ways. When the initial home loan application is processed, the lender may run a credit check on you, the guarantor. This will register as a ‘hard check’ on your credit history, and too many of these within a short period of time can negatively affect your credit score.

Furthermore, if you and the borrower can’t meet the mortgage repayments, it will be recorded as a default. This will typically put a large dent in your credit score and can make it harder to obtain credit or a loan in the future.

If you’re the guarantor for someone’s home loan and they can’t meet their home loan repayments, you’ll be required to do so on their behalf. This in turn could place you under mortgage stress and make it harder to meet your own home loan repayments.

And depending on the property’s value, the lender may choose to sell your home to make back the money they’re owed, leaving you stuck with a home loan but no home.

It’s important to factor in these possibilities if you’re thinking about guaranteeing a loan for someone.

A guarantor will typically remain attached to your home loan until the bank approves your request to remove them. Once your LVR is at 80%, you’ll generally be able to take steps to release your guarantor. If you really want to, some lenders allow you to release your guarantor at 90%, but this will typically result in you having to pay LMI from that point.