Navigating the World of Home Loan Guarantors: Pros and Cons

In the world of real estate, securing a home loan can often be a daunting task, particularly for first-time homebuyers. The financial landscape can seem insurmountable, with high down payments, rigorous credit checks, and the looming specter of Lender's Mortgage Insurance (LMI). But there's a solution that has gained popularity in recent years - the use of a guarantor. In this article, we will explore what it means to become a home loan guarantor, who can be a guarantor, and the pros and cons of using one.

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What Does It Mean to Become a Home Loan Guarantor?

A home loan guarantor is an individual or individuals who provide additional financial security for a mortgage applicant. This means that if the borrower fails to make their loan repayments, the guarantor is responsible for covering the debt. In most cases, lenders prefer guarantors to be close relatives, such as parents, grandparents, or siblings. However, this can vary from lender to lender, so it's essential to check with your chosen financial institution.

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Who Can Be a Guarantor?

While a close family member is often the preferred choice for a guarantor, there are specific requirements they must meet:

1. Equity and Stable Income: Guarantors must have equity in their property and a stable source of income to demonstrate their ability to support the loan.
2. Good Credit Rating: A strong personal credit rating is essential. Lenders typically look for guarantors with a satisfactory credit history.
3. Citizenship or Permanent Residency: Guarantors are usually required to be Australian citizens or permanent residents.
4. Age: Guarantors must be above the age of 18.

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How Much Money Does a Guarantor Need to Earn?

Lenders typically focus less on the earning capacity of a guarantor and more on factors like credit history. The primary determinant is the level of equity in the guarantor's property. Ideally, a guarantor should own their property outright. If not, they should have enough equity to cover at least 20% of the new property's value being purchased.

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Do Guarantors Get Credit Checked?

Yes, potential guarantors are subject to credit checks. Lenders want to ensure that the guarantor has the financial capacity to step in and repay the loan if the borrower cannot. While each lender may have its threshold for credit scores, having a high credit score is generally preferable.

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Does Being a Guarantor Appear on My Credit Report?

Becoming a guarantor itself doesn't usually appear on your credit report. However, it can impact your credit in certain circumstances:

• If the borrower you're guaranteeing for defaults on repayments, it can affect your credit record.
• Financial associations may be made between you and the borrower, which could influence future credit assessments when applying for loans.

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How Do Guarantor Loans Work?

In a guarantor loan, the guarantor provides a guarantee secured on their property. Typically, this is a parent assisting their child in buying a home. The goal is to help the borrower enter the property market sooner. Once the borrower has paid off part of the loan or the property has appreciated in value, they can apply to remove the guarantee.

How Is the Mortgage for the Guarantee Structured?

The loan is secured by both the property being purchased and the guarantor's property. If a limited guarantee is used, the guarantor can reduce their exposure to the mortgage. In cases where parents already have a home loan on their property, the guarantee for the loan is secured using a second mortgage behind their current loan.

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What Types of Guarantees Are There?

Several types of guarantees exist, depending on the circumstances:

1. Security Guarantee: The guarantor uses their real estate as additional security for the loan. If the guarantor already has a loan on their property, the bank may take a second mortgage as security.
2. Security and Income Guarantee: This option is often used when a parent assists a child with a low income or a student in buying their first property. The lender uses the parent's property as additional security and relies on their income to prove the loan's affordability.
3. Family Guarantee/Parent Guarantee: In this scenario, the guarantor is a family member directly related to the borrower. This is often referred to as a "parental guarantee," but grandparents, siblings, and other family members can be considered on a case-by-case basis.
4. Limited Guarantee: With a limited guarantee, only part of the loan is guaranteed by the guarantor. This is commonly used with security guarantors to reduce potential liability on the guarantor's property. Guarantees can be either limited or unlimited, depending on the guarantor's wishes and the lender's requirements.

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Pros and Cons of Using a Guarantor

The Pros

1. Get into the Market Sooner: With a guarantor's help, you may only need to save a smaller deposit, making it easier to get your loan approved and secure your dream home.
2. Removable Down the Track: As you repay your loan and build equity in your property, you can eventually remove the guarantee, leaving you solely responsible for the loan.
3. Avoid LMI: Accepting help with your deposit can help you reach the 20% threshold needed to avoid paying Lender's Mortgage Insurance.

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The Cons

1. Liable Guarantor: The most significant drawback is that if you, as the borrower, default on your repayments, your guarantor (often a family member) is liable for the portion of your debt they have guaranteed. It's essential to ensure you can service your loan repayments before proceeding.

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In conclusion, guarantor home loans can be a valuable tool for those looking to enter the property market with less upfront capital. However, it's crucial to understand the responsibilities and potential risks involved for both borrowers and guarantors. If you're considering this option, it's advisable to seek professional guidance to structure the arrangement in the best possible way. Please don't hesitate to reach out to us for personalized assistance in navigating the complex world of guarantor home loans and securing your dream home.

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