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Guarantors And Additional Securities

Our mortgage brokers deal with these situations frequently.

Additional mortgage securities and guarantors can strengthen low equity home loans.

In the current market it has become harder for a first home buyer to get a mortgage.  A common solution is to get help from parents or a guarantor, so let's explain how this can work for you. 

 

The cheapest mortgage has a 20% deposit

With a 20% deposit you don't pay additional fees, your interest costs will be cheaper, and your loan repayments are less meaning you can repay your loan faster.  Basically, it saves you a lot of money. 

With a 20% deposit you also have a wide choice of lenders and this can help us to keep a competitive edge to your home loan.  

If you don't have 20% saved to buy a house, a guarantor can help to bridge the 20% savings gap. 

However, a guarantor is not the only way to bridge the gap and involving a guarantor may not be advisable.  We explain why below. 

 

This is why lenders use guarantors

A guarantor is used by a lender to give additional security for their loan over-and-above their mortgage. 

In general, if a lender is forced to recover their loan using their powers as mortgagee and their "first line of defence" (i.e. the mortgage) was insufficient to recover their loan, the lender will then look to their "next line of defence" which is the guarantors.  

In most, but not all, cases guarantors will have also provided mortgage security (over their property) to the lender and this may be used by the lender as a lever to recover any outstanding monies owed.  Most lenders will want to know that the guarantor is capable of servicing the 20% gap if necessary. 

 

What this means for your guarantor

Unfortunately, this is not the place to give a detailed account of how a guarantor helps to protect the lender from incurring losses on their loan to you.  Suffice to say, your guarantor will have an exposure to the lender, whether limited to 20% or not, and they will remain exposed until they are released from their guarantee by the lender. 

 

Releasing a guarantor from their liability

Whenever a guarantor is involved in supporting another person's loan, the guarantor's liability should be limited to the minimum possible amount (say 20%).

There should also be a planned release of the guarantee at the outset.  Guarantors are normally released at 80% LVR.  This can be easily planned by way of loan repayments and, in times of moderate land inflation (say 3%), can be achieved relatively quickly by a the combination of loan repayment and inflation.  

 

Below is a simple example. 

  1. House price $400,000. 
  2. Land inflation 3% per annum.
  3. Loan terms: Interest rate of 7% pa on the entire loan. 80% of the loan is interest only for 5 years.  20% of the loan is repaid over a 5 year term.

 

StartYear 1Year 2Year 3Year 4Year 5
House value  $400,000  $412,000  $424,360  $437,091  $450,204  $463,710
80% x Interest only loan @ 7% pa  $320,000  $320,000  $320,000  $320,000  $320,000  $320,000
20% x 5 year table loan @ 7% pa  $80,000  $66,152  $51,303  $35,381  $18,308  --
Total debt owing  $400,000  $386,152  $371,303  $355,381  $338,308  $320,000
Loan to value ratio  100%  94%  88%  81%  75%  69%
Your equity  --  $25,848  $53,057  $81,710  $111,896  $143,710

 

Your guarantor should be able to be released at the end of year 3 (or very soon after) and after only 5 years you will have built up equity in your home of about $140,000 - thanks to your guarantor getting you started. 

 

Alternatives to involving a guarantor

We are reluctant to expose a parent's home as security for a child's home loan because, if something goes wrong, the parent could lose their home. 

 

Family loan

Often it is simpler and safer for parents to lend a child the 20% deposit required to get them started.  It restricts the parents' exposure to the loaned amount.  Parents retain their same level of control over their home and it is not tied in with the home loan repayment behavior of the child.  

Even if the parents get a loan top-up secured by their home, they are subjected to the normal credit guidelines to assess their ability to afford the top-up, and they are in control of the loan's repayment.  

We prefer this method but it isn't always an option so this is why parents acting as guarantor can be helpful. 

 

Second mortgage

A second mortgage can be a very effective and a relatively cheap way to get on the property ladder.

 

We will advise you of various options when we have your loan application.

 

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