The Pros and Cons of Using a Guarantor for Your Home Loan
Entering the Australian property market can be challenging, especially for first-time buyers facing high property prices and the need for substantial deposits. One option that’s gained popularity is using a guarantor on your home loan. This approach can help you secure a loan with a smaller deposit or even no deposit at all. However, like any financial decision, it comes with both advantages and potential drawbacks. This article will explore the pros and cons of using a guarantor for your home loan, helping you make an informed decision.
What is a Guarantor Home Loan?
Before diving into the pros and cons, let’s clarify what a guarantor home loan entails. A guarantor home loan is a type of mortgage where a third party, typically a close family member such as a parent, uses the equity in their own property as security for a portion of your loan. This additional security can help you borrow a larger amount or avoid paying Lender’s Mortgage Insurance (LMI).
Pros of Using a Guarantor for Your Home Loan
1. Lower Deposit Requirements
One of the most significant advantages of using a guarantor is the ability to enter the property market with a smaller deposit. According to data from the Australian Bureau of Statistics, the median house price in capital cities was $825,000 as of March 2023. A traditional 20% deposit on such a property would be $165,000, which is out of reach for many first-time buyers.
With a guarantor, you might be able to borrow up to 105% of the property’s value, covering the purchase price and additional costs like stamp duty and legal fees. This can significantly reduce the time needed to save for a deposit, allowing you to enter the market sooner.
2. Avoiding Lender’s Mortgage Insurance (LMI)
Lender’s Mortgage Insurance is typically required when borrowing more than 80% of a property’s value. LMI can add thousands of dollars to your loan amount. By using a guarantor, you can often avoid this cost entirely, even if you’re borrowing a high percentage of the property’s value.
3. Access to Better Interest Rates
Lenders often view guarantor loans as lower risk, which can translate to more competitive interest rates. A lower interest rate, even by a small margin, can save you thousands of dollars over the life of your loan.
4. Increased Borrowing Capacity
With a guarantor, you may be able to borrow more than you would on your own. This increased borrowing capacity can open up opportunities to purchase in more desirable areas or secure a property that better meets your long-term needs.
5. Faster Entry into the Property Market
The ability to buy a property sooner can be a significant advantage in a rising market. Historical data from CoreLogic shows that Australian property values have generally trended upwards over time, despite short-term fluctuations. Getting into the market earlier could mean benefiting from capital growth sooner.
Cons of Using a Guarantor for Your Home Loan
1. Risk to the Guarantor
The most significant drawback of a guarantor loan is the risk it poses to the guarantor. If you default on your loan repayments, the lender can pursue the guarantor for the guaranteed portion of the loan. This could potentially put the guarantor’s own property at risk.
2. Strain on Relationships
Financial arrangements between family members can sometimes lead to tension or strained relationships, especially if difficulties arise with loan repayments. It’s crucial to have open and honest discussions about expectations and potential scenarios before entering into a guarantor arrangement.
3. Limited Lender Options
Not all lenders offer guarantor home loans, which may limit your options when shopping for the best deal. You might miss out on some competitive rates or features offered by lenders who don’t provide guarantor loans.
4. Complexity and Legal Considerations
Guarantor loans are more complex than standard mortgages. Both you and your guarantor will need to seek independent legal advice before proceeding. This adds to the time and cost involved in securing your home loan.
5. Potential Impact on Guarantor’s Borrowing Capacity
By acting as a guarantor, your family member may limit their own borrowing capacity for future loans. Lenders will take into account the guaranteed amount when assessing the guarantor’s financial position for any new loan applications.
6. Difficulty Removing the Guarantee
Removing a guarantor from your loan typically requires refinancing or proving to the lender that you can service the loan independently. This process can be challenging and may incur additional costs.
Alternatives to Guarantor Home Loans
If you’re unsure about using a guarantor, consider these alternatives:
- First Home Owner Grant: Check your eligibility for government assistance programs designed to help first-time buyers enter the market.
- Shared Equity Schemes: Some states offer shared equity programs where the government co-purchases a portion of the property with you.
- Saving a Larger Deposit: While it may take longer, saving a 20% deposit can help you avoid LMI and secure better loan terms.
- Buying with a Partner or Friend: Pooling resources with another person can help you enter the market sooner.
- Rent-to-Buy Schemes: These arrangements allow you to rent a property with the option to purchase it in the future.
Using a guarantor for your home loan can be an effective way to enter the property market sooner, avoid LMI, and potentially secure better loan terms. However, it’s crucial to carefully consider the risks and responsibilities involved, both for yourself and your guarantor.
Before proceeding with a guarantor loan, have open discussions with your potential guarantor about the risks and expectations. Seek independent financial and legal advice to ensure you fully understand the implications of the arrangement.
Remember, while a guarantor loan can provide a pathway to homeownership, it’s essential to ensure that you can comfortably manage the repayments on your own. Your goal should be to release your guarantor from their obligations as soon as possible, allowing you to take full ownership of your property and financial future.
By weighing the pros and cons carefully and considering your individual circumstances, you can make an informed decision about whether a guarantor home loan is the right choice for your journey into the Australian property market.