How does a family guarantor work?
When buying a home, many potential homeowners face the challenge of saving for a deposit. In Australia, lenders typically require a 20% or a 5% (if utilising First Home Buyer Schemes) deposit to avoid paying Lender’s Mortgage Insurance (LMI). For some, this amount is hard to achieve, especially with rising property prices. A family guarantee is a financial tool that can help borrowers secure a home loan without a large deposit by having a family member, often a parent, act as a guarantor.
What is a guarantor home loan?
A guarantor home loan involves a family member, known as the guarantor, offering part of their own home’s equity or assets to secure the borrower’s loan. Essentially, the guarantor provides additional security to the lender, allowing the borrower to potentially avoid LMI and borrow up to 100% (or more) of the property’s value. If the borrower defaults on the loan, the guarantor's assets may be used to cover the shortfall, reducing the lender's risk.
Who can be a guarantor?
Lenders usually prefer close family members, such as parents, to act as guarantors. Some lenders may allow extended family members, like siblings or grandparents, but this is less common. The guarantor needs to have sufficient equity in their own home or property and demonstrate financial stability. Additionally, they must meet the lender’s requirements, including being an Australian resident and not having significant outstanding debt or poor credit history.
Types of guarantee home loans:
- Family or parental guarantee: This is the most common form of a guarantor loan, where a parent or close family member offers their property as collateral. The guarantor typically pledges the equity in their property, which serves as additional security for the borrower’s loan.
- Security guarantee: In this arrangement, the guarantor offers only the equity in their property to secure part or all of the borrower’s loan. This option is appealing to borrowers who need help reaching the deposit requirement but do not want their guarantor to be liable for any income or repayments.
- Security and income guarantee: This type involves the guarantor providing both equity in their property and supporting the borrower’s ability to repay the loan. In this case, the guarantor may have to demonstrate sufficient income to cover loan repayments if necessary.
- Limited guarantee: A limited guarantee allows the guarantor to limit their liability to a specific amount, usually the shortfall of the deposit or a percentage of the loan amount. This reduces the guarantor’s risk compared to a full guarantee, which covers the entire loan.
Pros and cons for the home loan borrower
Pros:
- Avoid LMI: With a guarantor, borrowers may be able to avoid the cost of Lender’s Mortgage Insurance, which can be expensive.
- Buy sooner: Borrowers can secure a loan with a smaller or no deposit, allowing them to enter the property market sooner.
- Borrow more: A guarantor may allow borrowers to access a higher loan amount, giving them more purchasing power.
Cons:
- Limited flexibility: Borrowers might be constrained by the loan conditions, which can sometimes be stricter when a guarantor is involved.
- Family pressure: Relying on a family member for financial support can strain relationships, especially if financial difficulties arise.
- Potential for repossession: If the borrower defaults, the guarantor’s property could be at risk, indirectly affecting the borrower’s family.
Pros and cons for the guarantor
Pros:
- Helping a loved one: Acting as a guarantor allows family members to support their loved ones in buying a home without providing direct financial assistance.
- No immediate financial outlay: Guarantors do not need to provide money upfront; instead, they offer the equity in their property as security.
Cons:
- Risk of asset loss: If the borrower defaults, the guarantor’s property may be repossessed to cover the outstanding loan amount.
- Financial liability: The guarantor could be held responsible for the borrower’s repayments, which may impact their credit score and future borrowing capacity.
- Complicated exit: It may take time for a guarantor to be released from the guarantee, depending on how quickly the borrower pays down their loan or increases the property’s value.
How and when can a guarantor be released from the home loan?
The guarantor can be released from the loan once the borrower has paid off enough of their mortgage or when the property's value has increased sufficiently, reducing the loan-to-value ratio (LVR) to below 80%. At this point, the borrower no longer needs the guarantor’s security to avoid LMI, and the lender can remove the guarantor’s responsibility. Alternatively, the borrower can refinance their home loan once their financial situation has improved, releasing the guarantor from the original loan agreement.
Case study examples
Sarah, First Home Guarantee Scheme, with a guarantor
Sarah is a first-time homebuyer looking to purchase a $600,000 home in Melbourne. She has managed to save only $15,000, which is just 2.5% of the purchase price—well short of the traditional 20% deposit required to avoid Lender’s Mortgage Insurance (LMI). However, Sarah qualifies for the First Home Guarantee Scheme, a government initiative that allows eligible first-time buyers to purchase a home with as little as a 5% deposit, without needing to pay LMI.
To make up the shortfall, Sarah’s parents, John and Mary, agree to act as guarantors, using the equity in their own home, which is valued at $800,000. By doing so, John and Mary provide additional security to Sarah’s lender, helping her reach the 5% deposit threshold needed under the First Home Guarantee Scheme. This arrangement allows Sarah to borrow the remaining $585,000 required to purchase the property without LMI.
Over the next few years, Sarah continues to make regular repayments, and her property’s value increases to $700,000. Once her loan-to-value ratio (LVR) drops below 80%, Sarah can apply to have her parents released as guarantors, removing their liability and freeing their property from any potential risk. By leveraging both the First Home Guarantee Scheme and her parents' support as guarantors, Sarah was able to enter the property market with a minimal deposit, avoiding significant costs and achieving homeownership sooner.
Tom, rentvesting, First Home Guarantee Scheme, with a guarantor
Tom is a first-time buyer who wants to enter the property market but doesn't have a deposit saved. Despite this, he is eager to start building wealth through property investment, so he decides to pursue rentvesting — buying an investment property in a more affordable area while continuing to rent where he lives.
Tom finds an investment property in Brisbane priced at $500,000 but has no deposit saved. Fortunately, he qualifies for the First Home Guarantee Scheme, which allows eligible first-home buyers to purchase a property with a deposit as low as 5%, avoiding Lender’s Mortgage Insurance (LMI). However, since Tom has no deposit, he relies on his parents, Jane and David, who agree to act as guarantors by using the equity in their home, valued at $900,000, to provide security for Tom's loan.
Tom’s current annual income is $75,000, but on this salary alone, his borrowing capacity is limited, making it difficult to secure the $500,000 property. To boost his borrowing power, Tom plans to rent out the property, with an estimated rental income of $450 per week, or $23,400 annually. This rental income increases his total assessable income to $98,400 per year, making him more eligible for the loan he needs.
With his parents acting as guarantors and the additional rental income factored into his serviceability assessment, Tom is able to borrow the full $500,000 required to purchase the investment property. The guarantor arrangement allows Tom to avoid the need for a deposit altogether while also helping him avoid LMI.
Over time, as Tom pays down the loan and the property’s value appreciates, he aims to reduce the loan-to-value ratio (LVR) to below 80%. Once this is achieved, Tom can apply to have his parents released from their guarantor obligations, ensuring their home is no longer at risk.
By leveraging the First Home Guarantee Scheme, his parents’ support as guarantors, and the rental income from the investment property, Tom successfully entered the property market without a deposit. This strategy allowed him to invest in a growing area, benefit from rental income, and start building wealth, all while continuing to rent in his preferred location.
A family guarantee can be a valuable tool for helping individuals secure a home loan when they don't have a large deposit. However, both borrowers and guarantors need to understand the risks involved. With careful planning, clear communication, and an understanding of how the process works, it can provide a pathway to homeownership without the financial burden of LMI.
