If you’re a future homeowner finding it tough to build up a deposit, there could be other ways to help you cross the finish line and into your first home faster. One of those options is a guarantor loan.
A guarantor loan allows a family member, most often a parent to use the equity in their own home as extra security for your property purchase. It’s a fairly common path for many first-time buyers.
Before you take the leap, here’s what you should understand about how guarantor loans work.
Typically, buying a property requires a deposit of 20 per cent. For many people, putting together that amount can be challenging and may take several years—especially with the rising cost of living.
A guarantor loan gives you another pathway into the property market. In some cases, having a guarantor might allow you to buy a home without needing a deposit at all.
Another advantage of having a guarantor is the potential to skip Lenders’ Mortgage Insurance (LMI). This insurance is usually required if your loan covers more than 80 per cent of the property’s value and protects the lender in case you can’t repay the loan.
In most cases, a guarantor is a close family member such as a parent, grandparent, or sibling who agrees to use the equity in their own home alongside your cash deposit.
Not familiar with equity? It’s simply the gap between the current market value of their property and the amount they still owe on their mortgage.
The guarantor isn’t required to contribute any cash at settlement. Instead, they agree to use a portion of their property’s equity as loan security.
Here’s an example of how it could work: Let’s say you’re purchasing a $800,000 home and you’ve managed to save a 10% deposit, or $80,000. Since a 20% deposit is typically needed to avoid LMI, you’d be $80,000 short.
Your parents step in by offering $80,000 of equity from their own home as added security. They won’t need to pay anything at the time of settlement—but if you default on the loan later, they could be held financially responsible.
Once you’ve built enough equity in your property, either through regular repayments or if your home’s value rises, your guarantor can be removed from the loan (note: exit fees may apply).
Before going ahead with a guarantor loan, it’s essential to understand the potential risks involved.
As mentioned earlier, if you are unable to keep up with repayments, your guarantor could become financially responsible. Their equity will also be partially tied to your loan, which might limit their ability to refinance or sell their home.
There is also the emotional aspect of combining family relationships with financial commitments to think about.
It’s strongly recommended to get both legal and financial advice before committing to a guarantor home loan arrangement.
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