Having a family member who owns the property to act as your guarantor means you can get a mortgage more easily. You don’t need to save all or some of the 20% of the property’s price and can avoid a hefty lenders’ mortgage insurance premium. However, there are risks you need to be aware of.
Limited Guarantee – this places a limit on the guarantee. Some lenders agree to limit the guarantee to only the amount you need. For example, a home buyer has a 10% deposit and needs another 10%. The lender limits the guarantee to the sum that makes up the other ten per cent, which gives a 20% deposit for the new home.
Unlimited Guarantee – this guarantees the full mortgage amount but may even cover the future loans etc of the person being guaranteed. This scenario is less desirable for the person who is the guarantor and needs to be carefully considered.
How does a guarantor mortgage work?
If you have a close family member with equity in their property (that means, they own all or most of the property), they can guarantee your deposit. You still need to borrow money from a lender and repay it, but the guarantor provides security.
That’s the catch: if you can’t repay the mortgage, your guarantor may have to.
To minimise risks, a guarantor can guarantee a portion of a loan, say, 20%. Once the borrower has repaid 20% of the loan, the guarantor’s property is safe even if the borrower fails to repay the remaining 80%.
Let’s examine the process with a typical guarantor scenario:
Guarantor mortgage scenario
John and Rachel purchase a $600,000 apartment, with a 5% deposit ($30,000).
Rachel’s parents own their home outright. They agree to guarantee a further 15% ($90,000) of the property cost, which eliminates the LMI cost completely.
John and Rachel repay $150,000 of their loan over the next few years. Rachel’s parents are no longer liable because the $90,000 they guaranteed has been repaid.
Who can act as a guarantor?
Some lenders only accept parents as guarantors while others accept close relatives. Every lender has different requirements, but the following criteria usually apply:
Finances and credit. A guarantor needs equity in their property, a stable income and a good credit rating to satisfy lenders.
Residency. Lenders typically want a guarantor to be a New Zealand citizen or permanent resident.
Age. A guarantor must be over 18 and usually under 65.
How much can I borrow with a guarantor?
With a guarantor, many lenders let you borrow up to 100% of the value of a property or even up to 110%.
Even if you have a 5% deposit saved, a guarantor can be beneficial. Having your parents guarantee a further 15% of the deposit means you can avoid paying LMI.
Note that some lenders require borrowers to have at least 5% of a deposit in genuine savings, even with a guarantor.
Risks and benefits of a guarantor mortgage
For the right borrower having a guarantor is a huge help. However, if you cannot make a mortgage repayment, your guarantor’s property might ultimately become the bank’s property.
Get into the property market faster. Once you’re in the market and paying off your loan, you can build up equity and enjoy capital gains if the property grows in value. If you spend more time saving up a 20% deposit without a guarantor, the property might grow in value and you need to save even more.
Avoid LMI. Lenders mortgage insurance can add thousands of dollars to your home loan. A guarantor loan takes this cost out of the equation.
Improve your chance of getting approved. Having a guarantor strengthens your mortgage application.
Your property is at risk. The guarantor risks their property if the borrower can’t repay their loan. It’s a serious risk and both borrower and guarantor need to understand it fully before entering a guarantor arrangement.
Relationship strain. Mixing family and financial relationships can cause serious emotional strain. You should evaluate not only your finances but your relationship beforehand.
Thankfully, a guarantor is only liable to repay the amount they guarantee. Once that amount is repaid the guarantor is released from further liability (the borrower, obviously, is not).
Planning to act as guarantor for your child? Ask these questions first
Can I afford to go guarantor? Assess your financial situation realistically. Plan out a scenario where you suddenly become liable for the full amount you guaranteed.
Can the borrower afford this loan? Try to assess the borrower’s financial situation as clearly as possible. Don’t make this judgement on instinct either: ask for hard evidence. You can request to see bank statements and a copy of their credit report, but it’s up to the borrower to share these with you.
How is your relationship with the borrower? Just because you’re close family doesn’t mean you get along at the best of times. Plus, with large sums of money involved even good relationships can become strained.
Have I sought professional advice? Get independent legal advice to make sure you fully understand the guarantor process.
What are my options if I can’t get a guarantor?
Having a parent who can guarantee your deposit is a privilege that many borrowers don’t have. Your parents may be able to help in other ways or you may have to go it alone. Here are some options:
Get a low deposit mortgage.Low deposit mortgages let you borrow up to 95% but LMI can be very expensive. You can capitalise LMI costs, meaning you fold the premiums into your mortgage and repay both together.
Co-buying. A co-borrowing arrangement means getting a loan with your parents and buying a property together. You and your parents are both liable to repay the entire loan. However, ownership arrangements can also be complicated.
Reinvest. If you can’t afford a home where you want to live, you could buy a cheaper property elsewhere and rent it out. You’re building wealth through an affordable investment while living somewhere else.
Richard Whitten is a senior writer at Finder covering home loans and property. He helps everyone understand the ins and outs of mortgages so they can make smarter property decisions. He has written for Money Magazine, Homely, and for multiple banks and lenders. Richard trained as a high school teacher but found it easier to manage personal finances than a classroom full of kids. Before joining Finder, he edited textbooks and taught English in South Korea. Richard has a Bachelor of Education, a Graduate Certificate in Communication and is currently studying a Certificate IV in Finance and Mortgage Broking.
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