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Becoming a guarantor for a home loan can be extremely beneficial for the borrower, but are there any rewards for you, the guarantor?

Becoming a guarantor for a home loan can be extremely beneficial for the borrower, but are there any rewards for you, the guarantor?

In home loan lending the most common type of guarantor is a security guarantor. This is where you go about to help your children purchase a home but instead of giving them a gift to add to the deposit you offer the equity you have in another property. The loan is then secured over both the property they are purchasing and your property, thereby substantially increasing the equity that the bank has available to it. It is often used to reduce the lending ratio to below 80% so that no mortgage insurance is levied. This can be a substantial saving and all without having to part with any cold hard cash.

There are actually no direct financial rewards for being a guarantor, but there are risks involved. Signing on to be a guarantor is as big of a commitment as being the borrower because if the borrower is unable to meet the repayments, you will be responsible for repaying the debt or the property you have offered as additional security can be sold to repay the debt.
Some possible risks involved with being a guarantor include:

Could affect your credit rating
If the borrower is unable to make repayments on the home loan that you have guaranteed, it is in your best interest  to step up and cover the repayments. However, if you are unable to help meet the repayments the loan, that default will then appear on your credit report and in turn, could affect your ability to get credit in the future.

May affect your ability to obtain credit in the future
If you apply for credit down the track, the loan that you have guaranteed will have to be included in your liabilities as an ongoing commitment. Even though you are not currently making repayments on that loan, the lender will still have to assess the amount. This could drastically affect your serviceability and your chances of taking out a loan.

May affect your future plans
The bank will have an interest in your property for a number of years until the loan is either paid down below 80% of the value of children’s property, or the value increases so that the loan is below 80%LVR. This means that if you wanted to sell the property it is going to impact your children. To remove the guarantee before equity has built up in their property may mean that mortgage insurance is subsequently charged or worst case the property has to be sold as there is not enough equity for it to stand alone without the guarantee. Think carefully about what you may want to do with the property in the next 5 to 10 year horizon before you decide to use it to guarantee a loan.

May affect your relationship with the borrower
If you end up having to make repayments on the home loan, it may very well strain your relationship with the borrower. Even if you have a fall out with that person, you are still legally bound to repay the loan. So, before you decide to guarantee the loan, consider what would happen if you did fall out with the borrower.

If you are considering becoming a guarantor for a family member or friend, there are ways to help reduce the risks. Some include:

Seek independent advice: It can be hard to keep emotions out of the equation when family and friends are involved. But, if you want to be a guarantor, you will need to think of this agreement as a business transaction. So, before you sign the dotted line, speak with a legal and financial professional to ensure this is something you can afford to do. It is advisable to keep the borrower separate from these discussions so there is less of a chance that your emotions will interfere with your decisions.

Discuss other options: If you still want to help your child, family member or friend purchase a property, but don’t want the risks of being a guarantor, there are other options that may be more suitable. Firstly, you could offer a one-off gift payment to cover the deposit fully or partially. This way you are not locked in to any ongoing responsibility.

Plan for the worst case scenario now: Many guarantors sign the dotted line without fully comprehending what they are signing up for. Even if you trust the borrower to be responsible and diligent with their repayments, some circumstances are out of a person’s control (eg. sudden illness or loss of their job) and the borrower may not be able to make repayments. If this was to happen, would you have the finances to cover the debt? Before you decide to become a guarantor, make sure you consider whether you could actually afford the repayments if something was to happen to the borrower.