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How a Guarantor Loan Works

According to Finder.com, approximately 33% of all first home buyers in Queensland use a gift or guarantee from their parents when buying.  Guarantor loans are becoming increasingly popular, giving parents the ability to help their children into their home by using their equity, not their cash.  They do this by putting a guarantee on the first home buyer’s loan by allowing the bank to put a “second mortgage” over their own home.

The standard setup for a security guarantor loan consists of 2 loans (thus reducing the parents’ exposure), as show below:

 

Guarantor Diagram

What is needed for a guarantor loan?

From the parents: all that is needed is equity in their own house to cover 20% of the purchase price.

The first home buyer will have to undergo a full assessment, but the main criteria are:

  • Australian citizenship or permanent residency.
  • Regular income i.e.:
    • Full-time or Part-time employment.
    • Casual employment for at least 3 months.
    • Self-employed for at least 12 months.

Can you pay off the parents’ portion of the loan first?

Yes.  Whilst both loan accounts must be paid from the day of settlement, we can setup “loan 1” as interest-only, reducing those repayments so the extra cash can be used to pay down the principle of “loan 2” as quickly as possible.

Is the Parent at Risk?

The short answer is yes.  If the borrower defaults on their repayments, the Bank is entitled to repossess their property in order to repay the two loan accounts.  If both loans are not fully repaid after the sale of the home buyer’s property, it is the parents’ responsibility to pay out the remainder (limited to their original liability – usually 20%).

What should be done before considering a Guarantor Loan?

Talk to a Mortgage Broker , seek independent legal advice, and read all loan contracts very carefully.  For more information on the risks involved, please visit ASIC’s page here.

 

If you have any questions, please comment or send me a message below.

 

References

https://www.moneysmart.gov.au/borrowing-and-credit/borrowing-basics/loans-involving-family-and-friends

https://www.finder.com.au/first-home-buyers-by-state

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