With housing affordability being a key issue facing all Australians, the ability for some young people to save a deposit for a house or unit is becoming increasingly difficult. To help your kids get into their first home sooner, you may think about becoming a loan guarantor.
Typically, someone that needs a guarantor may not have a big enough deposit saved. Without a guarantor, it could mean they need to pay expensive Lender’s Mortgage Insurance Fee or may potentially have their loan application declined.
A guarantor is someone who essentially commits a portion of collateral/ security in lieu of cash savings the borrower may not have. The guarantor doesn’t have the right to own the property or items bought with the loan.
Depending on the circumstances, a security guarantee can either be in full or limited. Usually banks will allow the guarantor to provide a limited guarantee for an amount sufficient to reduce the borrowing amount, for example, to less than 80% of the purchase price. This helps alleviate the need for Lenders Mortgage Insurance as well as reduce some of the risks and responsibilities for the guarantor.
Guarantors are generally immediate family members such as parents, spouses, de facto partners, siblings, adult children or grandparents; although others are considered in certain circumstances. To be a guarantor, you must also meet certain criteria set by the bank, such as being over 18, working (exceptions may apply) and have sufficient equity in your home.
Being a guarantor for a family member may help them enter the housing market with a smaller deposit, increase their borrowing capacity and potentially avoid the costs of Lenders Mortgage Insurance, but there are risks and responsibilities involved.
For example, if a family member defaults on their loan obligation then as the guarantor it becomes your legal responsibility (for the portion that you guaranteed). This responsibility might include the principal amount, any interest and default interest, as well as any fees incurred by the bank in resolving the default. If you are also unable to service the loan, the credit provider may sell the asset that you put up as security to pay the outstanding debt.
So, before agreeing to be a guarantor on a loan, do your homework.
1. Request a copy of the loan contract and understand how much the loan is for, the repayments, loan term, the interest rate, loan type and your own security obligations. In addition, you need to understand what happens if your family member defaults on the loan payment.
2. Consider your relationship with the person who is seeking loan approval. For example, if there's a breakdown of the guarantor arrangement due to a default on the loan payments, it could place a strain on the relationship.
3. Evaluate both of your financial situations. For example, can they afford to pay the loan in the event of long-term illness, or do they have the appropriate personal insurance? Do you have the capacity to cover the portion you guaranteed if ever needed?
4. Consider a limited guarantee. For example, you may be able to limit the amount of the guarantee. This may help to reduce your risk and responsibility.
5. If you're uncomfortable with the level of risk involved in being a guarantor, take the time to investigate other options, such as gifting or loaning the family member a portion of the required deposit.
6. Finally, talk to your solicitor and financial adviser to make sure you fully understand what is involved in becoming a guarantor and how it may affect your financial situation.
Being in a position to help a family member via a guarantor arrangement may bring a feeling of contentment. However, before making the commitment, carefully consider the risk and responsibilities involved, investigate other options available, understand how this may affect your financial situation, and seek professional advice.
Source: Financial Planning Knowledge Centre, 2017
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