Getting help from parents/ family - guarantors
When we purchased our first home, we were very set on the minimum amount of deposit we wanted. Of course, trying to save to build up a deposit is the first action plan that comes to mind; it takes time. Avoiding additional costs such as Lenders Mortgage Insurance (LMI) can also be a priority.
A guarantor can help speed up your journey.
How does it work?
A guarantor can use the equity in their own property as a guarantee to the lender that they would pick up repayments on the loan should the borrower not be able to. Having a guarantor in place alleviates the need for the lender to charge Lenders Mortgage Insurance (LMI), as the guarantor effectively takes on some of the risk of the borrower defaulting on the loan.
What is Lenders Mortgage Insurance (LMI)?
Lenders Mortgage Insurance is an insurance policy the lender takes out to mitigate the risk that you, the borrower, might default on the loan. This insurance policy covers the lender, not you (or any guarantor) and is paid for by the borrower.
LMI can be useful in the respect that it enables access to finance when your deposit is lower than 20%. The cost of LMI can be significant however, as it substantially adds to the overall cost of your purchase. A guarantor can alleviate the need for the borrower to pay LMI.
How can having a guarantor prevent me paying LMI ?
Imagine the property you would like to purchase is worth $700,000. To avoid LMI, lenders would generally require you to provide 20% of the property value as a deposit (a Loan to Value Ratio of 80% or $140,000). If you don’t have a $140,000 deposit, LMI would be triggered.
Assume your parent's home is worth $900,000 and fully paid out (no mortgage). You have a deposit of $50,000.
Your parents could instead decide to provide a guarantee of $90,000 (being the difference between your deposit of $50,000 and the $140,000 required by the lender to avoid LMI). They can do this by using the equity in their own home.
In using the equity in their home, the guarantor does not have to contribute any cash to the property purchase. Instead, they sign a guarantee, which confirms the lender can access the guarantor’s property in the event of the borrower defaulting on the loan.
The lender may require the guarantor to guarantee the entire loan, but it is possible to also guarantee a portion of the loan e.g. (In this case, just $90,000). The terms of the guarantee will vary from case to case.
As the borrower you need to be able to service the loan irrespective of that guarantee. If the borrower defaults, there are a few next steps a lender could consider to recuperate the money owed to them. This could involve selling the property or asking the guarantor to step in to service the loan.
Who can be a guarantor?
Guarantors are usually limited to family members. The definition of a family member will depend on the lender.
Benefits to you as a buyer
A Guarantor can help you reach the 20% threshold required to avoid lenders mortgage insurance, without having to stump up the additional cash.
It can help you buy a property with a small deposit.
No cash is needed to be contributed by the guarantor.
Things to consider
Buying with a smaller deposit means that you are borrowing a higher amount, and the overall costs of borrowing will increase.
The Guarantor could be asked to pay the loan should you default.
Being a guarantor can impact the guarantor’s ability to borrow.
A guarantor should always obtain legal advice before becoming a guarantor (most lenders will require this).
What next after the loan has been established?
Once you have paid off part of your loan or your property has increased in value, you can apply to remove the guarantor. The process for this will vary from lender to lender.
Additional information:
Some lenders will allow a higher LVR (a lower deposit amount) for certain professions before LMI is payable. For example, Accountants, Dr’s and Lawyers can access loans with an LVR of up to 90% without the need for LMI.
Contact us to find out more.
