How Guarantees Work?

With housing affordability and the difficulty to enter the property market becoming a greater focus for first home buyers and investors – the topic of guarantor loans is now coming to the forefront as a solution. Guarantor home loans allow people to buy properties without the major hurdle – saving their deposit – bringing forward the time they can make their first purchase as well as avoid costly fees such as Lenders Mortgage Insurance which would otherwise be payable without a 20% deposit.

What is a Guarantee and how does it work?

Guarantees are specific type of loan product/policy which is put in place to assist those with low/no deposits available to be able to purchase a property with the assistance of another party who has sufficient equity in a property (or a term deposit with some lenders) to ‘guarantee’ their purchase until their property has sufficient equity to have said guarantee removed.

Instead of providing the traditional deposit through cash/savings or borrowed funds released from the equity of another property, the equity of the guarantor property is used as ‘security’ to protect the interests of the bank should the loan be called in due to bankruptcy etc.

This means that the borrower can then potentially make a purchase with effectively no deposit and have the entire borrowing costs (stamp duty, government charges) capitalised onto the loan. Keep in mind that every lender has a different policy/set of rules with guarantors (and some do not allow guarantors at all), so what is allowable is dependent on the lender being used.

Once the loan is setup, the borrower pays the loan as they would a standard home loan – the guarantor is not required to make repayments on the loan.

Generally the bank that the guarantor is using for the mortgage on the property providing the guarantee needs to be the same lender used for the guarantor purchase (if they have a mortgage on the property), however in circumstances where it’s not possible for the purchaser to use this lender some lenders will be able to provide a ‘second mortgage’ – allowing the purchaser to use a different lender. This can cause a longer delay in the finance/settlement process and have larger fees to setup.

What are the benefits?

The benefits are obvious with guarantor loans – it allows borrowers to purchase a property with zero deposit, bringing forward the time it would take them to buy a property, so they can get into the market sooner, stop paying rent, buy instead of sitting through a rising market etc. Through purchasing via a guarantor, no lenders mortgage insurance (LMI) is charged which for first home buyers in particular can equate to 10’s of thousands of dollars saved from day 1.

What it looks like: Example

Sally is a first home buyer whose parents are providing a guarantee so she can purchase her first home sooner, with no deposit. The figures are as follows:

Property Being Purchased: $400,000

Guarantor (Parents) Property Value: $500,000

Parents Existing Loan: $200,000

Stamp Duty and other Government Charges: $19,520

Total loan required: $419,520 (purchase price + government charges)

Total amount required to be guaranteed: $99,520 (20% of purchase price + government charges)



Lenders will require the parents to maintain at least 20% equity in their home after covering their existing loans and any guarantor amount – which in this case would mean a maximum of $400,000 in loans secured against their $500,000 house. As their existing loan is only $200,000 and guarantor amount $99,520, they have more than sufficient equity to help Sally buy her first home.

Every lender is different with their specific policy on how much equity can be used for guarantees, how much equity must be left in reserve and who can qualify for a guarantee, so make sure you have your specific situation reviewed to ensure the best lender is used for your scenario.

Is this risky for the guarantors?

Those providing guarantees are liable up to the maximum of the guarantee amount (generally 20%+ stamp duty/government charges). Should the borrower receiving the guarantee have their property foreclosed and the bank is unable to recoup all costs from selling the property, the guarantors would then need to make up the short fall.

Statistically the primary reasons for this is medical issues and loss of income - which can be mitigated through ensuring appropriate protections are put in place to not only protect the guarantors from this risk, but also the purchaser so they do not have their most value asset at risk.

How to mitigate risks

To protect the borrower and people providing guarantee, always ensure you’re appropriately protected with life, income, TPD, trauma insurances etc.

Accelerating the repayment of your loan through early repayments or higher repayments set from day 1 can bring the date at which the guarantee can be removed ahead, reducing the window in where the guarantor can be seen as having a ‘risk’.

Removing the guarantee

Removing a guarantee is relatively simple – if the debt is paid down to have the property paid down to an 80% loan to value ratio (LVR), property value increase that the debt is now 80% LVR OR a combination of the two, the lender will allow the guarantee to be removed – generally after verifying the new equity position via a valuation.

Alternatively when the property has a 90% LVR, the guarantee can be removed and lenders mortgage insurance fee is put onto the loan through an internal refinance.

Through prudent planning from day 1, it can potentially be possible to use a guarantee to enter the property market and then remove the guarantee within 12-24 months.

Tip – Guarantees can also be used for investment

A number of lenders will allow guarantees for borrowers to purchase investment properties. This can allow you to build your portfolio sooner and redirect your funds for other purposes such as renovation funds. Add this type of finance strategy with a renovation/revaluation strategy can be a potent mix which can assist early investors build their equity position from a small deposit basis.

Instead of putting finite funds towards the initial deposit, these funds are instead kept in reserve for the renovation funds on a property with short term equity growth potential post renovation. Once the renovation is completed, the property can then be revalued and equity position re-assessed. Should the value have increased sufficiently, the guarantee can be released.

Is this possible for me?

Guarantor home loans are a non-general type of lending and have very specific policy requirements which differ per person and their scenario. This can vary between the type of people who are allowed to provide guarantees, the age of the borrowers/guarantors, maximum guarantee amounts etc. To find out whether a guarantor home loan may be possible for your circumstances, contact your finance strategist who will be able to guide you through the options.

 

I have always wondered, would this work where parents and their property is in another country ?

 

Generally not. Australian banks don't normally accept security from outside Australia - none that I'm aware of anyway.

 

It would need to be an Aussie security.

Good post Corey

Cheers

Jamie

 

Good post Corey.

Some lenders are better in this space than others, and make life far easier for all involved (particularly the guarantors). St George/ANZ come to mind here, relative to others who are likely to want income documentation and serviceability testing for the guarantors.

Other lenders allow the definition of who can be the guarantor to be stretched further, this can come in handy if the situation involves an uncle/sibling, rather than a parent.

 

Hi all,

Trying to get my head around this guarantor scenario.

Purchase PPOR only have 10% for deposit and stamps+fees. Bank won’t lend 90% because of IP debt. Parents go guarantor for 10%, Bank lends 80% settle on PPOR and avoid LMI. Look to sell IP and use proceeds to refinance and release parents from guarantor.

Is that roughly how it work?

 

Thanks for the explanation. Does the loan you get have to be with same financial institution as the guarantors bank? For example can guarantor be with CBA and you get loan with ANZ?

 

Good post Corey

But are we now encouraging cross collateralised loans, and throwing family in the mix with guarantees?
Do the banks limit the liability of the guarantee? For example, to the max amout of the gap? eg In the event of default by the borrower the guarantor is only liable to pay out 'their' portion of the loan (in your example above $99,520).

Personally I would prefer to see parents setting up a seperate loan, and on-lending to the kids. Keeping their security/loans seperate. Its a lot cleaner in the event something goes pear shaped.

A lot of people wouldnt understand the risk they are taking, even after spending considerable time having it explained.

Blacky

 

so with the risks, say the the people with the guarantee where to be foreclosed and the guarantors were no longer in a position to make up the shortfall, currently out of work and not so great health wise. I assume this would mean they are then putting their own house at risk now? or does it depend on how it's all set up?

 

Yes. Last time I was a guarantor for a loan I had to get something signed by a lawyer and a financial advisor saying I understood the risks involved.

 

That can indeed work that way. (so long as the lender allows IP based family guarantees, not all lenders are allowing this)

Yep - once again not all lenders allow this, this is a second mortgage guarantee. The timeframes and delays on these are a pain, will generally require you paying a fee to the other bank not getting the loan and potentially the guarantors having to get legal advice. Generally avoid it like the plague unless there is no other way of getting it done.

It all comes down the family situation and numbers.

With most lenders you can limit the guarantee to only the amount being guaranteed as standard, not the entirety of the debt.

Seperate loan and onlending can work in a lot of cases - but there's a few issues where a family guarantee works gets it over the line:

• Parents are unable to apply for the equity release for onlending due to policy (ie based on age, significant portfolio servicing constraints etc)
• Parents do not want to onlend to the children and have that payment arrangement hanging over the family relationship, instead would have the bank manage the payment of the debt. It's easy to ask mum and dad to forgive paying back money for a week or two compared to not paying the bank.

Fundamentally whether they onlend the money or provide a limited guarantee - if non payment is made and after foreclosure there is a shortfall which isn't recovered from the borrowers, that amount is going to be owing just the same. With any guarantee being provided, its imperative to ensure the children still have funds to commit (which they may have in offset etc), have appropriately set up their risk protections etc.

 

Thanks for answering my question. Can Guarantors guarantee more than the 20% deposit? If they guarantee more how does that impact serviceability? Is it still going to be looked at, can you cover serviceability on the whole loan or will it be only on the portion that you are getting?

So if someone guarantees 50% and you only need the other 50% is serviceability calculated on the 50% or the full 100%?

 

Wondering what banks at the moment which would allow a guarantor for investment properties?

 

Several banks will do family guarantees for investment properties but each lender has specific restrictions.

ANZ:

ANZ's guarantee can be provided by people other than parents such as grandparents, siblings and children.

They have restrictions too though such as the loan amount cannot exceed 107% of the purchase price, the total Lending against the Guarantor’s property cannot exceed 70% and repayments must be P&I - IO is not allowed.

St George/BoM/Bank SA:

They are similar to ANZ in that the guarantee can be provided by a family member.

This is also open to owner occ and investment purchases however if its a non 1st home buyer then its only available for clients purchasing owner occ properties. The guarantee cannot be more than 50% o the guarantor's security. Unlike some of the other lenders St George doesn't require the guarantors to demonstrate servicing.

CBA:

CBA is like St George and ANZ where the guarantor can be a different types of family members.

CBA have restrictions too. The individual guarantor cannot be receiving government pension and using their principal place of residence as security and its not available for off the plan purchases.

Macquarie:

Macquarie's FG is terrible IMO. Macquarie do owner occ and investment but the guarantor's property must be refinanced to Macquarie and the guarantor must demonstrate that they can service their portion of the debt.

Westpac:

Westpac only does parental guarantees but can look as exception at other finally members. The guarantor doesn't need to demonstrate servicing. The purchase may only be for a property for investment where the applicants don't own any other properties.

There are more restrictions, lenders, scenarios but I can't list everything in the one post.

 

What sort of guarantee? Most banks would allow guarantees for company loans for example - except ING.

 

Still plenty of lenders allowing it - the main reducing availability of guarantees has been in:

• the types of guarantors allowed (ie you used to able to guarantee friends and non family relations with a number of lenders previously, now it is largely just for spousal, brother/sister, mother/father, grandparents etc)
• lenders are showing greater caution in allowing multiple guarantees

Lenders have huge varying differences in the types of guarantees they will provide, so you will need to have a broker who has significant experience in helping with this type of finance to avoid potential mistakes/poor outcomes.

 

Corey - can I email you a question? I’ve got a bit of an issue and need some advice with loan structure

 

Not a problem - shoot through an email.