Getting into the property market as a first home buyer is a big feat in 2022. With property prices rising by up to 23% over the last year and interest rates tipped to rise in the months ahead, housing affordability is one of the biggest concerns facing first-time buyers.
It's no surprise that recent CoreLogic research indicates the number of first home buyers securing loans has dropped. Many are looking at alternative ways to finance their property purchase, and guarantor home loans are one such alternative.
To help you assess if this is the right move for you, let's walk you through how guarantor loans work, the pros and cons of this loan option and how this type of home loan can assist you as a first-time home buyer.
What is a guarantor home loan?
Saving up for a 20% deposit on a property purchase can be a significant challenge for first-time home buyers in Australia. It can take over eight years for those in Sydney to save for an entry-level home! These gloomy trends are why more first home buyers are exploring other options of securing finance - like guarantor home loans.
With guarantor home loans, a guarantor (often a parent or family member) will agree to put forward their own property as collateral for your property purchase. They will also bear the responsibility for the loan if you can’t meet your repayments.
Using a guarantor can help you avoid the hefty costs of lender’s mortgage insurance (LMI), even if you don’t have a full 20% deposit ready to go. If you’re wondering how that’s possible, it’s because your guarantor absorbs the risk you present to the bank, and offers a way to recoup the costs if you default on your loan.
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How does a guarantor home loan work?
So, what’s involved in taking out a guarantor home loan? Here are some key insights into how this type of loan works and the guarantor home loan requirements in Australia.
First up, you need to find someone to act as your guarantor. This is usually a parent or close family member who owns their home (or owns a residential property). Some lenders need your guarantor to be a parent, while others are happy to accept any kind of family member.
Next, you need to make sure your guarantor has a stable income and a good credit history. Additionally, they need to be an Australian citizen or permanent resident and aged between 18 and 65.
Typically, a guarantor can only guarantee a small portion of your loan (usually up to 20%). This cap lowers the risk for your guarantor. Once you’ve repaid this loan (or your property has risen in value and you’ve built up 20% in equity), you’ll then refinance to remove the guarantor from your property.
The potential cost savings of a guarantor home loan
One of the big drawcards of a guarantor loan is the ability to skip things like LMI. While it might sound like a small cost, LMI can end up running into thousands of dollars.
Let’s run you through two scenarios to illustrate the potential cost savings of using a guarantor home loan.
Scenario 1: No guarantor
- Danly is a first-time buyer wanting to purchase a $700,000 apartment. They’ve only got a 5% deposit ready to go ($35,000).
- Without a guarantor, Danly would need to pay an LMI premium of $30,675.45.
Scenario 2: Using a guarantor
- Jordan is also a first-time buyer trying to purchase a $700,000 apartment. They’ve also got a 5% deposit ready to go ($35,000), but have been able to secure a guarantor.
- Jordan’s parents agree to guarantee the remaining 15% ($105,000) of the loan deposit to eliminate the need for LMI.
Jordan has instantly saved over $30,000. Within the next 5 or so years, they will be able to repay enough to cover the guaranteed portion of the loan. This means their parents will no longer be liable and they can continue to repay the remainder of the loan.
How long does a guarantor stay on the home loan?
Generally speaking, guarantors are usually liable for a home loan anywhere between 2 and 5 years. The length will depend on when the buyer is able to repay the guaranteed portion of the loan, and how fast the property increases in value.
Let’s run you through the broad requirements of what needs to happen before a guarantor can be released from the loan:
- The buyer needs to have made repayments on time for at least the last 6 months
- The loan needs to have an LVR (Loan to Value Ratio) of less than 80%
- The buyer needs to meet all of the lender’s requirements (such as having a good credit history, stable income and employment)
Who can be a guarantor for a home loan?
As we mentioned, parents and family members are usually able to be a guarantor on a first-home buyer's loan. The guarantor will need to own their property outright (or at least have a good amount of equity available), have a stable source of income, and good credit history to be approved by most lenders.
If you’ve been asked to act as a guarantor by a family member, it’s important to know the risks of being a guarantor for a home loan:
- You may be responsible for paying back the entire loan (and interest!) if the buyer isn’t able to make their repayments.
- You may damage your credit report if the guaranteed loan isn’t paid back. This will be listed as a default on your credit report.
- You could jeopardise your relationship with your family member if things don’t go to plan and you’re put into financial hardship because of this loan arrangement.
What are the pros of a guarantor loan?
The most significant benefit of securing a guarantor loan is the potential for cost savings as a first-time home buyer.
- Avoid the expenses of LMI: with a guarantor putting forward their property as security, banks and lenders won’t charge you hefty LMI premiums (which can quickly add up to tens of thousands of dollars).
- Secure property with a lower deposit: a guarantor loan enables you to get into the market faster with less than a 20% deposit. In some cases, you may be able to secure a loan with just a 5% deposit, shaving years off your journey towards homeownership.
- Score a better interest rate: having a guarantor opens up more home loan options for you as a buyer. By lowering your risk as a borrower, lenders are more likely to give you access to more competitive interest rates. This can save you thousands of dollars in interest over the life of your loan.
Let’s run you through an example of what you could save in interest with a guarantor home loan.
If you want to secure a loan of $700,000 with a deposit of just 5%, you’d be stuck with a fixed interest rate of 3.44% to 4.34%. However, if you secured a guarantor loan that enabled you to reach a 20% deposit, you could score a variable interest rate as low as 1.99%.
Without a guarantor, you’d be paying over $450,000 in interest over the lifetime of your loan. However, with a guarantor loan, you’d be paying just over $192,000 in interest. That’s a potential cost-saving of $258,000!
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What are the cons of a guarantor loan?
There are obviously some drawbacks to consider before taking out a guarantor loan, which includes:
- Putting your guarantor at risk: if things go pear-shaped, your guarantor is responsible for repaying your loan and may even need to sell their own property to do so.
- Your guarantor could be on the loan for longer than expected: if the market changes, you struggle to pay off your loan, or your property doesn’t rise in value, your guarantor may be tied to your loan for longer than they’d agreed to.
- The potential for relationship strain: finally, a guarantor loan can put your family relationship at risk if you default on your loan and they’re pushed into financial trouble as a result.
Why are guarantor loans a helpful option for first home buyers?
Many first home buyers are considering a guarantor home loan in 2022 due to the pressures of housing affordability. Ultimately, it can be a practical way for first-time buyers to secure their first property sooner than otherwise possible.
With both regional (25.5%) and capital city (19.2%) markets seeing exponential price rises over the past 12 months, many first time home buyers are struggling to get their foot in the door. Guarantor home loans eliminate the need to save a large deposit and avoids the expense of LMI.
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Disclaimer: The views, information, or opinions expressed in this blog post are for general information purposes only and should not be relied upon. We have not taken into account specific situations, facts or circumstances, and no part of this blog post constitutes personal financial, legal, or tax advice to you. You should seek tax advice from your accountant, specific to your situation.