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How do guarantor loans work?

If you have you are unsure of a borderline home loan application being approved – a guarantor loan is one where a ‘guarantor’ (generally a family member) signs onto your loan and in doing so, increases your equity and chances of approval.

So, whether you don’t have enough money saved for the standard 20% deposit, or you’re having trouble getting a lender to approve your application, a guarantor loan could be the answer you’ve been looking for.

What is a guarantor loan?

A guarantor loan is similar to a regular loan, only it is one where a ‘guarantor’ (usually a parent or other family member) signs onto the loan to increase your equity. This can help with approval when the deposit is low or in some cases, it can help borrowers to avoid Lenders Mortgage Insurance (LMI).

For loan seekers who do not have the standard 20% deposit, having a guarantor sign on to the loan can often be the difference between having a home loan application approved or rejected. In some cases, it can also help borrowers to avoid the somewhat costly Lenders Mortgage Insurance (LMI).

Benefits of a guarantor loan

Get into the market faster. With a guarantor loan you can secure a home loan without needing to save for a 20% deposit.
Avoid Lenders Mortgage Insurance. With a guarantor loan you might be able to avoid the LMI premium usually charged when your deposit is below 20%.
Borrow more. In addition to skipping LMI, in some cases you will be able to borrow more than what you could have without a guarantor (sometimes as high as 105% of the purchase price).

How do they work?

Guarantor loans work by having the guarantor offer up part of their home as equity in order to increase yours. In most cases, guarantors are limited to family members, namely parents, although sometimes siblings, grandparents or extended family will be accepted. The exact policy depends on the lender.

Despite being signed onto the loan, guarantors do not have any rights over the property. They are however, usually required to step in if the mortgage holder begins to lapse on payments. As such, agreeing to be a guarantor is a big responsibility.

How much can I borrow with a guarantor loan?

With a guarantor signing onto the loan, borrowers can generally take out much higher loans than otherwise possible, and many lenders will even offer loans of up to 100% of the purchase price. Some will even go as high as 105%. To find out what you could be approved for, it’s best to ask your lender as it will differ depending on your circumstances as well as the lender’s policies.

Depending on the type of guarantor loan you are looking for, the following generally applies (although as always, it’s best to check with your lender):

First home buyers: up to 105% of the property value.
Construction loans: up to 105% of the land value plus the cost of construction.
Debt consolidation and purchase: 110% of the property value.
Refinancing: Usually 100% of the property value.
Investors: up to 105% of the value of the investment property.

Do I need a deposit?

Whether or not you need a deposit (along with the guarantor guarantee) will depend on the lender. With a guarantor signing on, some lenders will accept an application with no deposit while others will still expect a deposit of at least 5% genuine savings. It can also depend on how much equity the guarantor is willing to secure you for.

Many with saved deposits of 10 – 15% also benefit from a guarantor to make up the rest since it can help them to avoid LMI costs.

Types of guarantees:

Security guarantee: This is when the guarantor uses assets (such as property) as security for the loan. In this case the borrower usually has a good credit history so it looks unlikely that the guarantor would ever have to step in but due to the lacking deposit a guarantee is needed.

Security and income guarantee: This is when the guarantor uses assets (such as their own house) as well as their income as security for the loan. This loan type is usually used when the borrower looks most at risk since the lender knows that the parent’s income would be able to sustain the loan.

Limited guarantee: This is when the guarantor chooses to only secure part of the loan. This is a good option for guarantors who are worried about overcommitting themselves and is usually used by those offering up assets to reduce the risk.

Eligibility: Who can be guarantor?

In most cases, the guarantor of a home loan will be a family member such as a parent or even a sibling, grandparent or extended family member. The exact policy will depend on the individual lender.

In some cases, friends of the home loan holder can also take on the role of guarantor, although this is more unusual. Being a guarantor is a big responsibility and guarantors should be sure to think about the impact the commitment could have on them, remembering that they will be asked to step in with repayments if the borrower can’t.

To be a guarantor, you need to have equity to offer up which means guarantors are usually required to be homeowners themselves. In addition, you will need to be over 18 and, in most cases, an Australian citizen or permanent resident. Sometimes the guarantor will also need to have a stable source of income although in most cases being a home owner is the main requirement.

Potential guarantors should also keep in mind that worst case scenario, they could be putting their own home at risk if the home loan holder was to default.

Are there protections for guarantors?

The Australian Banking Association has launched a new 2020 Banking Code of Practice which contains guidelines on the treatment of guarantor loans. These include:

Guarantees will not be accepted until 3 days after you have been provided with information, giving you time to review and seek legal advice (although if necessary, in some cases this time can be waived).
Guarantor documents will be giving to the guarantor by the lender or a legal representative, and not by the borrower, helping to avoid risk of pressure. If signed in the presence of the lender, the lender will ensure the lender is not present.
On the event of default, the lender will first seek assets from the borrower before approaching the guarantor.
The lender will give the guarantor information relating to the borrower’s deteriorating financial position within 14 days of the event.

What does a guarantor have to provide?

Documents: Guarantors need to provide evidence that they would have the ability to pay off the loan, so these documents could include proof of equity (e.g. the title deed to the house) as well as bank statements.
Checks: The lender will likely be interested in the guarantor’s credit history and run a check, so it is important that the guarantor has a good credit score.

Can a pensioner be a guarantor?

While most lenders would prefer the guarantor to be earning an income, in some cases this will be allowed. However, since being guarantor poses you significant financial risk, if you are no longer working it’s important to fully understand the potential consequences of the agreement and seek legal advice.

What happens if a guarantor cannot pay the loan?

If the home loan holder defaults, it is up to the guarantor to handle the home loan repayments. If they cannot do this, the lender is able to sell any of the security that was offered up by the guarantor when they originally signed onto the job. This means there is potential for the guarantor to lose their own house.

Can a guarantor be removed?

When you sign on to be a guarantor, they type of guarantee you signed up for will contribute when (or if) you will be able to end the guarantor contract.

If you only signed up for a specified term, your commitments will be waived once that time pasts (or of course, if the home is paid off first).

If you signed on as guarantor for the duration of the home loan, in most cases the lender will not consider any requests for release until a certain level of equity is reached.

Can the guarantor change their mind?

Being a guarantor is a big decision and unfortunately, if a guarantor changes their mind after the arrangements have been finalised it is unlikely that they will be able to leave the commitment.

Since the loan has been granted based on the guarantor’s finances, unless the home has developed equity in most cases the guarantor will be unable to leave the arrangement.

How do you ask someone to be a guarantor?

Being a guarantor is a big decision, and not one that should be taken lightly. When asking someone to be your guarantor, it is important to consider your relationship with them and how they being guarantor might impact it.

For example, what would happen to your guarantor (and to your relationship) if you were to default on the loan and they had to step in? What if they needed to sell their house to cover the costs?

In most cases, a guarantor should be:

Someone you have a close relationship with (eg. Parent)
Someone who is financially secure.

Being a guarantor is an act of goodwill, so when asking someone to be your guarantor, it is important to make sure they understand the full breadth of their commitment. For this reason, it might be worthwhile to seek legal advice.

It is also important that you have a robust plan in place to pay off your loan to help prevent them ever needing to step in.

What happens if a guarantor dies?

If a guarantor dies, the debt does not die with them. Instead, the guarantor’s estate can be liable. In this situation, legal advice should be sought.

Can I be a guarantor twice?

For parents with multiple children, you might be wondering whether you can be guarantor twice. Unfortunately, in most cases you can only be guarantor for one loan at a time. However, once that loan has been paid off there should be nothing stopping you from being guarantor again.

Potential impacts: Should I sign on as guarantor?

Agreeing to be a guarantor is not a decision that should be taken on the whim, and something that should instead be carefully considered.

Guarantors are financially liable if the home loan holder defaults, and worst-case scenario, losing their home if unable to cover the borrower’s repayments. It could also impact the following:

Purchasing investment property: Being a guarantor could affect your chances of being able to buy an investment property. If you are signed onto a loan as ‘guarantor’ this means that some, if not all, of the equity of your house is ‘tied up’ in the loan. Keeping this in mind, if the only way you can afford to buy an investment property is with a loan, you might not be able to do this due to not having enough equity.
Your credit rating: Being guarantor poses no risk to your credit rating, provided you can meet the loan holder’s repayments if they can’t. If you both can’t meet the loan repayments, you might start to see a negative impact on your credit rating.
Selling your house: If the loan is in its early days and a significant amount of it is reliant on the equity of your home, you might not be able to sell. Unless enough of the loan has been paid off that you are able to apply to have your guarantor loan responsibilities removed, you might find yourself stuck for the time being.