A guarantor home loan is a loan secured, in part, by the equity in another party’s property — typically a family member. The added security of a guarantor means you can borrow more for your home purchase than if you go it alone.
A traditional home loan, to compare, is based solely on the borrower’s finances, which can be limiting for people with bad credit, little savings or lower incomes.
How does a guarantor home loan work?
Guarantor home loans, sometimes called family pledge loans or family security loans, involve relatives using the equity in their own property as collateral for the borrower’s mortgage.
The equity is typically used to satisfy the minimum deposit of the loan. For example, if you want to buy a property worth $500,000, you typically need to put down 20% ($100,000) to avoid lenders mortgage insurance (LMI). Let’s say you have $50,000 but need another $50,000 to reach 20%. A guarantor home loan allows you to use $50,000 of equity in a family member’s home to make up the difference. The guarantor doesn’t need to pull out the equity or provide it in cash, it simply acts as a guarantee on the loan.
How much can you borrow with a guarantor?
The amount you can borrow is based on the equity in the guarantor’s home and the combined financial health of both you and the guarantor.
Lenders still require evidence that you can manage the loan repayments, regardless of whether you have a guarantor.
🤓 Nerdy Tip
In some instances, your lender may allow you to use the equity in a family member’s property to cover 100% of the deposit — these loans are known as 100% mortgages.
Going guarantor on a home loan
As a guarantor, you’re giving the lender permission to use your property as additional security for the loan. This means the lender can request the amount you had guaranteed in equity if the borrower defaults on the loan. You are not required to pay this amount using the equity, but it may be your only option if you cannot come up with the cash. This could mean selling your house to settle the other loan.
As guarantor, you can choose how much of the loan you wish to guarantee, depending on your financial situation and how much of your loan you are comfortable vouching for. The safest and most common option is simply guaranteeing a portion of the house deposit.
Who can be a guarantor on a home loan in Australia?
Since the guarantor provides the additional security for your home loan, most lenders prefer the guarantor to be a close relative such as a parent or sibling. Yet, depending on the lender, a guarantor could be an uncle or aunt, a grandparent or even an ex-spouse.
How long does the guarantor remain the guarantor?
The guarantor can apply to be released once the equity in the home exceeds the amount they guaranteed.
It’s worth noting that it may take years for the guarantor to be released from their commitment if the borrower’s property’s value falls or fails to grow at an expected rate.
Pros and cons of a guarantor mortgage
- Borrow more than you would on your own. The added security of a guarantor’s property may help you secure a bigger loan.
- Get a more competitive interest rate. This type of home loan can help borrowers get a more competitive interest rate, given the added loan guarantee.
- Buy a home with less than ideal credit. Guarantor home loans can make a big difference to those with negative marks on their credit report. A guarantor lowers the risk to lenders and may help people with credit issues get on the property ladder.
- Financially secure guarantors may not be easy to find. To get a guarantor home loan, you’ll need to find someone in a strong financial position who is willing to act as a guarantor, which may not be an option for some.
- Not all lenders offer guarantor home loans. You may need to shop around for this type of loan as they’re not offered by all lenders.
- Interest rates can be higher than traditional loans. Historically, interest rates on guarantor mortgages have been higher than those offered on regular mortgages.
Pitfalls to consider
As a guarantor:
- You are responsible for the amount you guarantee. Therefore, if the homeowner can’t make repayments, you may have to sell your property to pay the lender back.
- You are putting your finances (and home) in someone else’s hands, so make sure you trust the person you’re backing and are open about your concerns.
- If the borrower’s house sells for less than what’s left on the mortgage, you may be responsible to pay the lender the amount you guaranteed.
As the mortgagee:
- Be clear with the guarantor about what you are asking them to do. Let them know all of the cons, as well as the pros.
- Review the contract’s fine print to ensure the guaranteed amounts are correct, and the process of releasing the guarantor is as straightforward as possible.
- Having your finances linked to a loved one in this way can cause tension, especially if there is any concern about your ability to keep up with repayments. Before applying, consider whether this would place an unnecessary strain on your relationship.