A guarantor is a co-signer on a loan that “guarantees” that the payments will be met. A guarantor is often used for mortgages, especially for first time home buyers. By using a co-signer, individuals have the opportunity to enter the home-owner market more easily and quickly, and it can reduce costs significantly.
Below, we run through what guarantors do, why you may need one and how having one can reduce your overall costs.
Why would I need a guarantor?
A guarantor will take on some responsibility for the loan, and guarantee that the payments will be met by offering their own home or assets as security.
When an individual takes out their first mortgage, they may be required to pay 20% or more of the total amount they’re borrowing as a deposit.
For example, if Jack is borrowing $500,000 for a house, he will need to provide a down payment of $100,000. If Jack only has $20,000 in savings, then he may still be able to get the home loan, but he will have to pay Lender’s mortgage insurance.
What is Lender’s Mortgage Insurance (LMI)?
Lender’s mortgage insurance is a premium that protects the lender in case the borrower defaults on their payment. The amount of LMI a borrower may pay will differ depending on their loan.
Is it possible to avoid LMI?
Yes. Essentially, there are two ways that you can avoid paying LMI. The first is by saving a deposit that’s high enough for the lender to not require LMI because they will consider you low risk for meeting your repayments. This amount is required to be 20% or more of your total mortgage amount.
The second way to avoid LMI is by having a guarantor on your loan. The guarantor will take responsibility for the gap between your deposit amount and the total amount that’s 20% of your mortgage. For example, if Jack has saved a $20,000 deposit for his $500,000 home loan, he could ask a guarantor to sign off on $80,000 and avoid paying LMI.
What do guarantors have to do?
A guarantor will be responsible for the gap amount that they sign off on, as mentioned above. They will be required to use their own home, or assets, as collateral or security to prove to the lending institution that they can cover this amount should the borrower default on payments.
A guarantor won’t have to exchange or pay any money when they co-sign on a loan. However, should the borrower default on payments then the guarantor may be responsible for covering the amount of money they’ve signed off on.
Once the borrower meets the 20% mark, in which LMI wouldn’t be required (in this case, once Jack has paid $100,000 off his loan total), then the guarantor can request to be removed from the loan. However, this may vary depending on the lender’s terms and conditions.
Sometimes, releasing a guarantor may require the borrower to refinance their loan, which can be complex and may incur extra fees and charges. So, it’s very important to always read through the terms and conditions of your potential loan carefully and to discuss all possible future scenarios with your guarantor.
Who can be a guarantor?
Most banks and financial institutions prefer a direct family member, like a parent, grandparent or sibling to be a guarantor for a loan. However, some lenders allow indirect family members to be guarantors.
If you’re interested in finding out more information about using a guarantor for a loan with Rostron Mortgages, you can contact us via email or phone to speak to a specialist.