The Pros and Cons of Having a Guarantor
The Australian dream of owning your own home is significantly harder to achieve than it was just a couple of decades ago. But the answer isn’t necessarily to work harder and save more for a deposit––a guarantor can help realise the dream of homeownership.
What is a guarantor?
A guarantor is an immediate family member who offers either their house or a term deposit as security to help borrowers attain a home loan. To use a guarantor, you first need to be able to prove that you can afford to make the loan repayments on your own. Their role isn’t to help you make your repayments, it’s simply to reduce the bank’s risk of the borrower defaulting on the loan.
Life gets in the way of saving for a deposit. Studying, paying rent, prioritising travel and just the general cost of living all mean that you could spend your whole life trying to accumulate a deposit to purchase a home. A guarantor means that you don’t need to save forever to get your foot into your own door.
A guarantor can help you avoid paying Lenders Mortgage Insurance (LMI) which can potentially save you thousands of dollars. LMI is an insurance policy (at the expense of the borrower) designed to protect the lender from financial loss in the case that the borrower is unable to meet their home loan repayments. LMI is generally required when the borrower’s deposit is less than 20% of the value of the property being purchased.
Depending on the value of the security being offered by the guarantor, the borrower may have a wider choice of loan products available to them, meaning they may be able to get a much lower interest rate than what would’ve been attainable without a guarantor. This can also help with debt consolidation. Any minor debts, such as credit cards, can be consolidated into the home loan.
The positive aspects are significant but the negatives cannot be ignored as there can be serious consequences that come with the guarantor option. Consider the negatives before asking someone to take on the responsibility.
If the borrower was to default on the loan and the sale of the home was unable to cover their liability, then it’s up to the guarantor to make up the difference. This could mean the guarantor loses their house to pay back the debt the borrower got themselves into by defaulting.
The guarantor’s ability to borrow will be diminished once they’ve signed the agreement which could be an issue if they suddenly wanted to apply for their own loan.
The guarantor can be released from the agreement once enough equity has been built up but this may attract various fees.
There aren’t just financial risks to weigh up when deciding whether to have a guarantor. You would be tied financially to a close family member which poses a threat to the relationship if something was to go wrong. While it can be very beneficial, it’s a decision not to be taken lightly.