Continuing on the theme of understanding home loans. I thought I should discuss guarantors and what they are all about. There is lots of incorrect information floating around about guarantor loans. I think it is time to get the right facts and on the table.
Let’s start with the question everyone asks – “will I lose my house (usually the parents who are the guarantors) if my kids (usually the borrowers) don’t pay their loan?” The answer is………….maybe! BUT more than like NO! So let’s talk more about this.
Most guarantees in 2016 (now a days) are limited guarantees which means the guarantor only allocates a portion of their available equity to support the borrower’s purchase. What this means in layman’s terms is, if the family home is worth $400,000 and Mum & Dad have a mortgage of $200,000 owing, then the bank will allow them to use a portion of this against the property, this is usually up to 80% or in this specific instance $320,000. This means that there is $120,000 that can be used as additional security for the borrowers home loan. What this actually means is that there would be no need for the borrower to provide a deposit and this $120,000 acts a guarantee. Let’s park this for now talk about why guarantors are a great option for clients.
Firstly a guarantor is a great way for clients to avoid contributing a deposit as described above but more importantly it avoids the need to pay loan mortgage insurance – when you think about it, it can really save a borrower thousands of dollars. The potential savings for first time borrowers this is a great way to enter the property market with little or no money up front.
So what are the other benefits?
Clearly, there are significant benefits from a guarantor with borrowers not needing a deposit and paying not mortgage insurance but there are a few more.
If the borrowers are lending at a lower LVR (you might want to read our BLOG on this), you may have access to cheaper interest rates. I am starting to see a lot more banks set their rate on the loan limits and borrowers who are at the upper end are being charged almost 1% more than those who are under 80%. This means your repayments will be lower. In addition to potentially cheaper rates, some banks (lenders) will allow borrowers to consolidate some minor debts such as car loans, credit cards and personal loans – this can help borrowers afford home loan repayments and cleans up their overall financial affairs. Guarantors loans can be used for construction purposes and this allows the borrower to purchase a house and land package at 100% of the purchase price of the land and build contract.
There are some benefits to the guarantor themselves too. The banks will often limit the size of the guarantee to either 20 or 30%. This is a safe guard to enable to guarantor to do this multiple times should want to or purchase other property if they need to. Remember it is a limited guarantee which means that the guarantor is liable for their portion and not the full amount. Another really good thing is the guarantor in many instances does not need to undertake any financial assessment – this mean no payslips, no financials or investigation into their financial affairs, this provides some privacy for guarantor. The guarantor will need to be interviewed and they will need to acknowledge the guarantor and provide details of the property ie mortgage balances/statements and allow a valuation to be completed – that’s basically it!
It is important to understand the other side of the equation. The guarantor is responsible for loan in a default situation. It is also important to note that all banks will work extensively with the main borrowers firstly to enable them to fix up any missed payments but in the event that this unsuccessful then this will fall back to the guarantor. I cant stress this more – the onus of responsibility falls on borrowers first! Now what is important to note is there are a lot of options available to borrowers along the way should they do run into difficulty – all you need to do is consult your bank. In most instances if there is a martial split, a death or any other serious issue the borrowers generally will take upon themselves to sell the property rather get into any serious arrears – this is obviously remove the guarantor from any potential loss.
It must be said that guarantors generally need to be immediate family. In order to protect all parties banks and brokers should recommend independent legal advice even if it is not required. Why, because this provides the borrower to seek clarification on the rights, responsibility, terms and conditions to what is ahead of them.
I am often asked how you remove the guarantor. A guarantor has no time frame and can be removed at any time provided that there is a) enough equity in the primary property alone to facilitate a refinance b) the main borrowers have savings to contribute or c) the guarantor is substituted with another guarantor and their security ie moving from a mum and dad to a brother or sister or other family member. In some of these instances mortgage insurance maybe applicable so this is something the borrower will need to discuss with their guarantor and broker.
In a nutshell, guarantor loans are not evil and certainly not a noose around anyone’s finances if used wisely, they can be great for people to enter the property market.
As always if you need help with a guarantor loan don’t hesitate to call!
Dean