One of the biggest barriers to first home buyers entering the property market is the deposit required. Even when buyers have amassed what feels like a sizeable deposit, they then have to borrow more money for lenders mortgage insurance, because their deposit is less than 20% of the purchase price of the property.
It's possible to get a home loan with a low, or even no deposit, but first, let's look at why banks need a deposit in the first place.
Let's say you're buying a house for $500,000, and you need a loan of $400,000 to complete the purchase. A bank will generally feel comfortable with this amount. In the event of you defaulting and being unable to make your loan repayments, the bank is sure it can sell your $500,000 home for at least $400,000 home in order to get their loan amount back.
But what if you needed to borrow $460,000 on the same property? The bank would start to get uneasy, knowing that in the event that you default, a slight dip in the property market could mean that they don't get their money back. This is where lenders mortgage insurance comes in. It's a form of insurance you have to pay, and it protects the bank, not you, in the event that you default. How much LMI you pay depends on the percentage loan you get against the property.
So how do you avoid paying LMI if you've got less than a 20% deposit? One option available to some borrowers is to get a security guarantee, or guarantor loan. Guarantor loans work whereby a guarantor, usually a parent of an applicant, allows a lender to place a 2nd mortgage over their property, equal to 20% of the property being purchased. Using our above example, a second $100,000 mortgage would be held over the parent's property. Having 2 properties lowers the risk for the bank, and as such you don't have to pay LMI. The guarantor doesn't actively pay down the loan, and they don't have to pay anything at all provided that the loan applicants don't default. If they do default, they are liable for the portion of the loan which can't be recouped from the sale of the first property.
Guarantors receive independent legal advice before the loan is approved, and as brokers, we assess their financial situation to ensure that they've got other strategies to cover any shortfall in the event of a default, rather than having to sell their own home. However, it's important that guarantors try to look at this situation objectively, as there are potential risks involved for the guarantor.
If you'd like to check your eligibility for a guarantor loan, get in contact with us now.