For many Australians, saving a 20% deposit to secure a home loan can be challenging, especially with rising property prices. Enter the guarantor—a potential lifeline for first-home buyers and those struggling to get a foot on the property ladder. While having a guarantor can make homeownership more accessible, it’s not without risks. Understanding the pros and cons is essential for both the borrower and the guarantor.
Here’s a detailed look at the advantages, risks, and considerations of using a guarantor to secure a home loan in Australia.
What is a Guarantor Home Loan?
A guarantor home loan allows a family member—usually a parent—to use their property as security for part or all of the borrower’s home loan. This reduces the need for a large deposit or Lenders Mortgage Insurance (LMI).
The guarantor does not provide cash but instead offers equity in their property as a guarantee. If the borrower defaults, the guarantor becomes responsible for the portion of the loan they guaranteed.
Pros of Buying a Home with a Guarantor
1. Reduced Deposit Requirements
- Benefit: Borrowers can secure a home loan with little to no deposit, often just covering upfront costs like stamp duty.
- Example: Instead of saving a 20% deposit, borrowers may only need a 5% deposit or less.
2. Avoid Lenders Mortgage Insurance (LMI)
- Benefit: LMI is typically required for borrowers with less than a 20% deposit, costing thousands of dollars. A guarantor can eliminate this expense.
- Example: On a $600,000 home loan, avoiding LMI can save over $15,000.
3. Access to the Property Market Sooner
- Benefit: With the help of a guarantor, buyers can enter the market sooner, potentially benefiting from capital growth.
4. Better Loan Terms
- Benefit: A guarantor reduces the lender’s risk, which may result in lower interest rates or better loan terms.
5. Boost for First-Home Buyers
- Benefit: A guarantor can help first-home buyers who may struggle to meet strict lending criteria due to limited savings or credit history.
Cons of Buying a Home with a Guarantor
1. Risk to the Guarantor
- Issue: If the borrower defaults on the loan, the guarantor’s property may be at risk.
- Example: If a guarantor provides a $100,000 guarantee and the borrower defaults, the lender can pursue that amount from the guarantor’s property.
2. Potential Strain on Relationships
- Issue: Financial arrangements between family members can create tension or conflicts, especially if financial difficulties arise.
- Example: Missed repayments or misunderstandings about the guarantor’s obligations can lead to strained family relationships.
3. Limited Guarantor Flexibility
- Issue: The guarantor’s ability to refinance or sell their property may be restricted while the guarantee is in place.
4. Borrower’s Financial Pressure
- Issue: While a guarantor eases initial affordability, borrowers still need to manage ongoing repayments, which may strain their budget.
5. Increased Guarantor Liability
- Issue: If property values fall, the guarantor may face liability for a larger portion of the loan than anticipated.
Eligibility Requirements for a Guarantor
To qualify as a guarantor, the individual must:
- Be an immediate family member (e.g., parent, sibling, or grandparent).
- Own a property with sufficient equity.
- Have a stable financial position and a good credit history.
- Be fully informed about the risks and obligations of acting as a guarantor.
How to Minimize Risks for Both Borrowers and Guarantors
1. Limit the Guarantee Amount
- Guarantors can limit their guarantee to a specific portion of the loan, such as 20% of the property value, reducing their liability.
2. Understand the Terms
- Both parties should review the loan agreement and guarantor terms carefully, preferably with legal and financial advice.
3. Build an Exit Strategy
- Plan for the guarantor to be released from the loan as soon as possible, such as when the borrower’s equity exceeds 20%.
4. Consider Insurance
- Guarantors may consider insurance products, like income protection or loan protection insurance, to safeguard against unexpected financial issues.
5. Communicate Clearly
- Ensure both parties understand the financial implications and establish open communication to avoid misunderstandings.
Example: How a Guarantor Home Loan Works
- Scenario:
- A borrower wants to buy a $600,000 property but has only $30,000 saved (5% deposit).
- Without a guarantor, the borrower would need LMI, adding significant costs.
- With a Guarantor:
- A parent offers a $120,000 guarantee (20% of the property value).
- The borrower avoids LMI and secures the loan with a lower deposit.
Is a Guarantor Home Loan Right for You?
A guarantor home loan can be an excellent option if:
- You have a trusted family member willing and able to act as a guarantor.
- You have a stable income and a clear plan to manage repayments.
- You want to save on upfront costs and enter the property market sooner.
However, it’s not suitable for everyone. Borrowers and guarantors should weigh the risks and benefits carefully and seek professional advice before proceeding.
Final Thoughts
Using a guarantor to secure a home loan can make homeownership more achievable, especially for first-home buyers. However, it’s a decision that requires careful consideration and planning. By understanding the advantages, risks, and responsibilities involved, both borrowers and guarantors can navigate the process successfully.
At DDP, we specialize in guiding borrowers and guarantors through the complexities of home loans. If you’re considering a guarantor arrangement, our experts can provide tailored advice to help you make the best financial decisions.
Ready to explore your home loan options? Contact DDP today to get started!
