Article by Mozo
With property prices around Australia skyrocketing in recent years, saving up a sizeable deposit isn’t an easy feat, especially when you are paying rent. The median house price in Australia’s capital cities is now $595,000, more if you live in Sydney and Melbourne. This means to save the recommended 20% deposit, you’d need savings of $119,000.
An option for first home buyers to get into the market is to co-borrow or have a family member act as guarantor for your home loan. Many lenders will allow this type of arrangement but it is important that both parties understand the risks, as well as the benefits.
If you become a co-borrower, also called joint applicant, on a home loan you will be legally responsible for the loan until it is repaid in full. It is common for couples to be joint applicants on a home loan but sometimes friends go in together to purchase property this way. If you are a joint applicant, the bank or lender will take both sets of income, assets and liabilities into account to determine the total loan amount.
A guarantor home loan on the other hand, helps you secure your home loan by your parent’s or family member mortgaging a portion of their own property as security for your guarantor home loan.
This guarantee can be released without the full loan being repaid. Generally most banks will only allow parental guarantees, though there are some instances where other immediate family members like grandparents, siblings and defacto partners will be considered.
Whether it’s your parents or a close family member acting as home loan guarantor it’s mandatory for them to get independent and legal advice from a solicitor and accountant/financial advisor to ensure they fully understand the implications of going guarantor.
The idea is simple really. If you are a first home buyer who hasn’t saved up a deposit of 20% (and has a Loan to Value Ratio (LVR) above 80%), you can ask your parent’s or a family member to be your home loan guarantor using the equity they hold in their property as security for a portion of your home loan. The amount that is secured is up to the guarantor and can be anywhere between 5% up to 100% of the loan amount.
Scenario: Nick has just landed his first full time job and is on a salary of $50,000 per annum. While Mozo’s borrowing calculator shows he could afford to borrow up to $300,000 and Nick knows he can comfortably meet the ongoing repayments with his current job, the only problem is he has only saved up a 5% deposit. Eager to get into the property market, Nick asks his parents to go guarantor on the remaining 15% to give him an LVR above 80%, so he can avoid the cost of lenders mortgage insurance (more on this later).
Thousands! By getting your parents or a family member to become a home loan guarantor, you will avoid the hefty cost of lenders mortgage insurance, plus you won’t have to worry about saving up a large deposit.
What is lenders mortgage insurance, you ask? If you have a deposit of less than 20% of the property value, providers in Australia will deem you a higher risk and take out an insurance to protect themselves if you can’t pay off the guarantor home loan. This insurance is called lenders mortgage insurance (LMI).
But if your parents become guarantor for your home loan and put up a portion of their home as collateral, you’ll no longer be deemed a risky borrower.
There’s one main risk when it comes to guarantor loans and it’s that the guarantor is liable if you’re unable to meet your repayments. In the worst case scenario, if you default on the loan and the bank can’t recover their loss in full when selling your property, they could potentially go after your parents property, as a last resort.
For this reason, banks generally prefer investment properties to be used as a guarantee rather than the family home. But keep in mind the lender can only retrieve the portion your parents secured your guarantor home loan with and once you have paid back that amount in repayments you can apply for your parents to be released as home loan guarantor.
Scenario: A couple of years down the track the company Nick is working for has a major restructuring and he is made redundant. While his payout covers the next 3 months of repayments, after this period if Nick struggles to find a job and defaults on his home loan, the bank could then seize his property to recover their loss. If they can’t get back their money in full, his parent’s home will be the next in the firing line and the bank could sell his parent’s property. However, keep in mind the bank can only retrieve the 15% portion that Nick’s parent’s secured his home loan with. That’s why if your parents are considering guaranteeing your home loan, it’s always better for them to secure the loan with a small portion of their home.
The main home loans available with a guarantor facility are from the major players in Australia, as most smaller lenders don’t offer this option. While you might be keen to get into the market as soon as possible, remember to conduct a little recon work to ensure you get the best deal for you. Here are some top things to consider when you begin your home loan comparison:
Fixed vs variable rate: You’ll soon notice there are two types of interest rates available in the home loan world - the option to lock in your rate or leave it variable. The fixed rate option is often popular with first home buyers as it gives you the security that your repayments will remain consistent over the fixed rate period (usually 1 to 7 years). But the more popular option overall is variable rate loans, as it provides homebuyers with more flexibility, like the ability to switch providers without incurring an exit fee (breakfast fees are often charged with fixed rate loans).
Comparison rate: Whether you go for a fixed or variable option, you’ll still need to check what the comparison rate is, as this will give you a better idea of how much the guarantor home loan will cost you once the fees are factored into the equation.
Extra repayments facility: Building up equity in your home by making extra repayments is a smart way of getting your parent’s released as home loan guarantor sooner. So make sure you sign up with a home loan that allows fee free extra repayments and as soon as you come into extra cash from a pay increase or work bonus, pump that straight into your guarantor home loan, so that once you’ve paid back the portion that your parents secured the loan with you can apply for them to be released as guarantor and your parent’s home will no longer be at risk.
Offset account: Another good option for reducing the amount of interest you’ll incur is an offset account. It works just like a regular everyday transaction account and the balance is offset against the home loan principal.
Scenario: If Nick has an offset account with $10,000 in it, he would only pay interest on $290,000, instead of the full $300,000 home loan amount.
As you can see taking out a guarantor loan is risky business, so if you decide to go with this option, follow these tactics to ensure smooth sailing for both yourself and your guarantor:
1. Calculate your repayments
While a parental guarantee may mean you can get into the property game earlier, make sure you can actually afford the repayments without stretching yourself too thin. Punch in your numbers into our repayments calculator, to see how much you could comfortably afford coming out of your bank account each month.
2. Ensure you can afford a rate rise
Interest rates are at record lows at the moment but have you thought about whether you could afford your ongoing repayments if your lender was to increase rates in the future? You can use our rate change calculator, to see how much a rate lift could affect you.
3. Keep up a good savings habit
While a guarantor home loan means your parents help you take out a loan and avoid the cost of lenders mortgage insurance, you will still be assessed by the bank’s lending criteria, as they will want to see that you can comfortably service the loan. The type of things they’ll check is whether you have genuine savings by looking at your bank and savings account statements for the last 3 months and your credit card and personal loan statements to see if you’ve been on top of your payments.
4. Take out mortgage protection insurance
Different to lenders mortgage insurance mentioned above, mortgage protection insurance protects you (not the bank) financially if you were to lose your job or become ill, by paying your repayments for a set period of time for you.
Scenario: By taking out mortgage protection insurance, this would mean Nick’s repayments would be covered until he found a new job and his parent’s home wouldn’t be put at risk.
For more hints and tips for purchasing your first home, head on over to our first home buyers hub or read our in depth first home buyers - what you need to know guide.
Or if you are ready to start comparing the different loans available for first home buyers, head on over to our first home loans comparison table.Home loan features guides