Questions to ask before becoming a home loan guarantor
Being a guarantor is a great way to help a friend or family member purchase their home sooner, but before you jump in, you need to know what you are getting yourself into.
As a guarantor, you will not receive any direct financial rewards. Signing on to be a guarantor is as big of a commitment as being the borrower because if the borrower is unable to meet the repayments, you will be responsible for repaying the debt or the property you have offered as additional security can be sold to repay the part of the debt you guaranteed.
Do I have to put up assets as security?
In home loan lending the most common type of guarantor is a security guarantor. This is where you offer the equity you have in a property you own which the borrower uses as additional security for their loan. The loan is then secured over both the property they are purchasing and your property, thereby substantially increasing the equity that the lender has available to it. This helps the borrower by reducing the amount they need to contribute as their deposit. It also reduces the lending ratio to below 80% so that the borrower is also saving by not having to pay lenders mortgage insurance.
How much am I guaranteeing?
The guarantee can either be for the amount needed to keep the loan to an 80% lend or for the full loan amount.
Usually the guarantee is the amount needed to keep the loan to an 80% lend. Potentially it will be 20 – 30% of the purchase price of the new property. Before signing on the dotted line, you need to know exactly how much you will be guaranteeing. Chat with the lender as well as the borrower about the amount and ensure you double check it in writing before signing the contract. If you feel it is too much, speak with the lender to see if it can be reduced. This may not be possible as it is usually the minimum that they require.
If the guarantee is not restricted and applies to the 'total amount owing’, if the borrower is unable to repay the loan, once their property is sold to recoup costs then you would have to come up with the balance of funds still owing or sell your property to pay this amount. Once costs like interest, fees and legal costs are added to the debt, it could be a lot more money than what they initially borrowed.
As mentioned above, the most common type of guarantor for home loans is a security guarantor. So, if the borrower is unable to meet repayments and you are the guarantor, the lender is allowed to sell your property in order to repay the debt owing.
What restrictions are there if I want to sell the property?
You probably need to ensure that the property you use as security is one you are going to keep for the long term. If the situation arose that you had to sell the property, then the additional security would be removed from the loan. If the loan amount is above 80% of the value of the property, then the borrower would have to pay lenders mortgage insurance or come up with the funds to keep it to an 80% lend. Due to the reduction in how much the borrower is contributing the loan could be higher than they are willing to lend even with lenders mortgage insurance. In this case they may not allow your property security to be released or insist on someone contributing cash to keep it to the maximum they will allow with just one security.
Whatever the case, it can be very messy and costly to remove the guarantee if you want to sell so this would be a major consideration prior to agreeing to the guarantee.
Should I get legal advice?
To ensure that you understand the full implications of your guarantee, most lenders will insist on you getting your own legal advice. The legal practitioner will fill in a form stating that you understand the legal implications of the guarantee. Most of this will be around the worst case if the borrowers were to default on the loan but also on what restrictions this places on the property that you are using like what happens if you want to sell it or want to borrow funds against it yourself.
Financial advice from a financial planner or accountant could also be useful. They will chat to you about your future plans and ensure that the guarantee is not going to restrict you from doing what you want in the future.
Can I have a copy of the contract?
As you are in effect a party to the loan, the lender will issue you a copy of the loan contract. The contract will have all the information you need in one place. The home loan contract can tell you the loan amount, the interest rate, fees and charges, the loan term and the repayments. It will also detail the amount and terms of your guarantee. This document can be taken with you when you get legal and financial advice.
What are my other options?
If you still want to help your child, family member or friend purchase a property, but don’t want the risks of being a guarantor, there are other options that may be more suitable. Firstly, you could offer a one-off gift payment to help with the deposit. This means that the borrower wouldn’t have to repay it. It could also be a repayable gift which could be repaid over a period of time. This would have to be disclosed to the lender and factored into the ongoing commitments of the borrower.
Most importantly, it would be wise to seek professional financial advice before signing the dotted line to ensure this is the right option for you.