Using a guarantor to buy your first home

For first home buyers, Mitch and Jeffrey, the trickiest part about purchasing a property is saving up the deposit. Even though they have managed to save $120,000 so far, this falls short of a 20% deposit required for their desired price range ($800,000 - $900,000). 

Their mortgage broker informs the couple that if they borrow more than 80% of the property price, their lender will charge them Lenders Mortgage Insurance (LMI) – a one-off, non-refundable insurance premium that will be added to their loan. 

Not wanting to add thousands of dollars to their loan amount, Mitch and Jeffrey ask their broker if there’s a different way to get into their own home sooner.  

Securing a guarantor 

Mitch and Jeffrey ask Mitch’s parents whether they would feel comfortable providing a guarantee for their home loan. Having paid off their mortgage years ago, Mitch’s parents have equity in their home which makes them eligible to be guarantors. Using some of the equity in Mitch’s parents’ home as security for Mitch and Jeffrey’s mortgage would enable them to avoid additional costs like LMI. It would also make them a more attractive prospect to lenders.  

The four of them discuss what’s involved in being a guarantor – including the risks that Mitch’s parents would be taking on. After plenty of consideration, Mitch’s parents decide they’re comfortable and are happy to play a part in helping their son and his partner buy their own home.  

What are the risks of being a guarantor? 

Guarantors use their own home as security for someone else’s mortgage and agree to take on responsibility for the home loan if repayments can’t be met, so it’s not a decision to take lightly. Anyone considering being a guarantor should seek independent legal and financial advice before accepting the role. In fact, most lenders will insist on this prior to accepting a guarantee. 

Making an offer 

Soon afterwards, Mitch and Jeffrey find a two-bedroom apartment close to the Melbourne CBD that’s on the market for $850,000. They know they will have to put aside around $35,000 from their savings of $120,000 to cover the purchase costs such as legal fees and stamp duty. That leaves them with an $85,000 deposit, which is 10% of the estimated property price.  

Without a guarantor, Mitch and Jeffrey would have a Loan to Value ratio (LVR) of 90% and most lenders would require them to pay LMI. Depending on the lender, the LMI cost would likely be around $17,500. However, Mitch and Jeffrey won’t have to pay this cost as they have secured a guarantor.  

Mitch and Jeffrey make an offer on the apartment for $850,000 and its accepted. 

Setting up the guarantee 

Mitch and Jeffrey’s broker works closely with the lender and Mitch’s parents to set up the loan.  

Under the guarantee arrangement, Mitch’s parents use $85,000 of the equity in their property as additional security for Mitch and Jeffrey’s mortgage. This reduces Mitch and Jeffrey’s LVR to 80%, which means they will not have to pay LMI.   

The settlement goes through without a hitch. Mitch and Jeffrey move into their new apartment and start making repayments on their loan. They decide to make extra repayments as often as they can so they can release Mitch’s parents from their guarantee arrangement as soon as possible. 

Several years later, after Mitch and Jeffrey have paid down some of their mortgage and built up equity in their property, their broker helps them refinance their loan so they can remove the guarantee. This releases Mitch’s parents from the loan and removes the security over their property. It also means Mitch’s parents are no longer liable for the $85,000 they guaranteed.  

Who can be a guarantor? 

Guarantors are usually limited to immediate family members. Normally, this would be a parent, but it can include siblings and grandparents.