You want to ask your parents to go guarantor for you, but what do you need to know?
Guarantor loans are a handy way to get started on the property ladder. In an era of increasing property prices and the corresponding increase in deposit sizes needed, they are the quickest way to get your foot in the door. But how do guarantor loans work?
When you have a guarantor (usually a parent) on your loan, they guarantee 20% of your property purchase price as a portion of their own assets, usually in the form of their property. Very simply, this means that if you buy a $500K property, instead of needing to have a 20% deposit in the form of $100K cash and borrowing the remaining $400K, you can have a $100K mortgage placed over your parents property and you can borrow the full $500K. While the obvious benefit here is that you don’t need to spend years amassing a sizeable deposit, there are a few drawbacks.
For starters, your parents need to be in a financial situation in order to allow this to happen. Contrary to popular opinion, banks aren’t evil just for the sake of being evil, and they really don’t want to be pressured into a situation where they have to sell your parent’s house if you default and they can’t recoup their loan they’ve given you. In the event you did default, they will sell your home first (like any other default situation), and then try to make up any shortfall between the loan they gave you, and your properties sale price with liquid assets from your parents. Again, this simply means that lenders would rather that your parents are able to sell some shares or other assets in order to make up the shortfall if your house sale doesn’t cover your initial loan. If a bank feels that your guarantors don’t have sufficient liquid assets, then they may decline the loan.
A bank selling your parents home from underneath them is exactly the kind of press coverage that lenders are keen to avoid.
Another potential downside is that having a second mortgage placed over your parents property, even if it’s just sitting there and they’re not actively having to make repayments, will limit their ability to borrow, and to do anything with their property. While there is a mortgage over it, it will be treated like an ongoing commitment, and could impact their plans if they want to move properties as they reach retirement age.
For you, when you borrow the entire purchase price of a property, it means a few things. Yes, it gets you in the door sooner, but it will also limit your ability to refinance to a cheaper lender down the track. For example, you typically need to wait until your loan is about 80% of the value of your home before you can refinance to another lender. If you’ve put in a 15% deposit initially, this will occur fairly quickly in a steadily growing market. However, if you borrow 100% of the purchase price, it can take some time before the capital growth of your property allows you to switch lenders.
A common misconception is that your parents are guarantors to help you with your repayments because they’re a bit much for you to handle by yourself. This is known as a “servicing guarantor”, and is distinct from the above example of a “security guarantor”, and servicing guarantors are now a thing of the past. Under responsible lending rules, banks really don’t want to give you a loan you can’t afford to repay yourself. This is also good news for borrowers, as getting left high and dry with a loan you can’t afford is a common worry for many first home buyers.
If your parents do agree to go guarantor, they will need to provide a letter of independent advice to the bank, showing that they have sought independent legal advice from a party not affiliated with the home purchase (and therefore with no beneficial interest in it). Far from being just another hoop to jump through, this is one step in the home buying process which can give you the peace of mind that your parents have critically assessed the risks involved in becoming guarantor before they’ve signed on the dotted line.
For any further advice on being a guarantor have a chat with Link Advance today.