This is one of the most misunderstood and emotional issues around borrowing money. An important distinction is that there are different types of guarantees that affect how liable the guarantors are.
A limited guarantee limits the risk for the guarantor.
Having a guarantor helps minimise this risk of your mortgage which can provide several advantages:
- Avoid Lenders Mortgage Insurance which can be up to 3% which is $15,000 on a $500,000 purchase price.
- Remove the need for genuine savings.
- Occasionally qualify for a better interest rate or deal.
- Allow you to use your savings to clear existing debts providing a cleaner, safer start to your mortgage.
Limited (Partial) or Full Guarantees
An important distinction is that there are different types of guarantees that affect how liable the guarantors are.
In a Limited Guarantee, the guarantee is limited to a pre allocated amount. This means that the liability is also limited which minimises the risk for the guarantor.
An Example of Limited Guarantee
Now lets look at a worst case scenario. The property was uninsured (!!), burnt to the ground and the land only sold for $200,000. The guarantor would only be responsible for their guarantee which in this case is $80,000. The lender would hold you liable for the remaining $120,000.
A Full Guarantee would mean that guarantor could be held liable for the full $200,000.
On Limited Guarantees the guarantor is not on the title of the purchase property so there are no implications for first home benefits.
Full Guarantees simply mean that the guarantor is an equal borrower and is equally responsible for the full debt.
Generally the guarantor (or co borrower) is required to be on the title for the house. Depending on the lender, this is around a 5% share. The nice thing about the small share is that when you remove the guarantor from the title you only pay stamp duty on the share, not the whole property.
How it works
To give a Guarantee the guarantor supplies a separate property to help secure you mortgage. For this reason, the guarantor is generally a close relative. With many lenders they need to be employed, but in some cases the guarantors income is not required. This means that retiree’s such as grandparents are eligible.
For this to occur there needs to be available equity in the property to cover the guarantee. Equity is the difference between what the property is worth and what is owing. So a $500,000 property with a $200,000 mortgage has $300,000 in equity.
Occasionally a Guarantee is needed to support income in the short term. The only acceptable scenario is where the borrowers are expecting a significant pay increase to service the mortgage on they’re applying for. An example of this is completing university studies and earning a professional income. In this case, the guarantor would also need to be on the title of the property being purchased for at least 5% of the purchase price.