Understanding Guarantor Loans: Security Guarantor vs. Servicing Guarantor

Purchasing a home can be challenging, especially when saving for a large deposit or meeting lending requirements. This is where guarantor loans come in, a solution that allows family members, typically parents, to help borrowers secure a loan by leveraging their own financial position. In this article, we’ll explore the concept of guarantor loans, the roles of a security guarantor and a servicing guarantor, and the benefits and risks involved.

Parents supporting their children as guarantors for a home loan can make homeownership more achievable.

What Is a Guarantor Loan?

A guarantor loan involves a third party (the guarantor) who provides additional security or financial backing to the borrower’s loan. Guarantors act as a safety net for the lender, reducing their risk and helping the borrower secure a loan that they may not otherwise qualify for.

Guarantor loans are particularly helpful for:

• First-home buyers with little or no deposit.

• Borrowers looking to avoid Lenders Mortgage Insurance (LMI).

• Applicants with a good income but limited savings history.

Who Can Be a Guarantor?

When considering a guarantor loan, it’s essential to understand who is eligible to act as a guarantor. Typically, lenders have specific criteria for guarantors to ensure they have the financial stability and legal capacity to provide support. Below is a detailed overview of who can be a guarantor:

1. Immediate Family Members

Lenders generally prefer guarantors to be immediate family members due to the close relationship and shared financial interests.

Common examples include:

• Parents: The most common guarantors, as they often have substantial equity in their property.

• Siblings: Some lenders allow siblings to act as guarantors, particularly if they are financially stable.

• Spouses or Partners: A guarantor can also be a legal spouse or de facto partner.

2. Extended Family Members

While less common, some lenders may consider extended family members if they meet the financial criteria. These could include:

• Grandparents: Especially if they own property outright.

• Aunts and Uncles: Subject to the lender’s policies and financial assessment.

3. Friends or Non-Relatives

In rare cases, some lenders may accept friends or non-relatives as guarantors. However, this is uncommon and often requires:

• A significant level of trust between the borrower and the guarantor.

• Evidence of a strong financial relationship or shared interests, such as business partnerships.

4. Requirements for Guarantors

Lenders will typically assess a guarantor's financial position and legal capacity to ensure they are eligible. Key requirements include:

Financial Criteria:

• Property Ownership: Security guarantors must have equity in their property.

• Stable Income: Servicing guarantors need a steady income to meet repayment obligations if required.

• Good Credit History: A solid credit score is essential to demonstrate financial responsibility.

• Low Debt Levels: Guarantors should have manageable liabilities to reduce risk.

Legal Criteria:

• Age Requirements: Guarantors must be at least 18 years old, and some lenders may have an upper age limit (e.g., retirement age).

• Residency Status: Most lenders require guarantors to be Australian citizens or permanent residents.

Personal Circumstances:

• Financial Independence: Guarantors must not rely on government benefits as their primary source of income.

• Understanding of Risk: Lenders often require guarantors to seek independent legal and financial advice to ensure they understand their obligations.

5. Multiple Guarantors

In some cases, lenders may allow multiple guarantors to support a single loan. For example:

• Parents as Joint Guarantors: Both parents may use their combined property equity to secure the loan.

• Siblings or Relatives Together: If equity is split across multiple properties, multiple guarantors may be used.

Types of Guarantors

There are two main types of guarantors in a guarantor loan: the security guarantor and the servicing guarantor.

1. Security Guarantor

A security guarantor provides collateral (usually equity in their property) to secure the borrower’s loan. This does not involve cash payments but rather using the equity in the guarantor’s property to reduce the loan-to-value ratio (LVR) of the borrower’s loan.

How It Works:

• The guarantor uses equity from their property as additional security for the borrower’s loan. For example, if a borrower wants to purchase a property worth $500,000 and has saved a 10% deposit ($50,000), a guarantor can assist by securing an additional 10% of the purchase price ($50,000) using the equity in their property. This allows the borrower to meet the required 20% deposit without needing to pay Lender's Mortgage Insurance (LMI).

Key Features:

• No funds are withdrawn from the guarantor’s property.

• The guarantor is only liable if the borrower defaults on the loan.

• The borrower repays the full loan amount as if they had provided the deposit themselves.

2. Servicing Guarantor

A servicing guarantor supports the borrower by helping meet loan repayment requirements. This usually happens when the borrower’s income is insufficient to service the loan on their own.

How It Works:

• The guarantor’s income is included in the loan assessment to meet the lender’s servicing requirements.

• The guarantor may be required to make repayments if the borrower cannot.

Key Features:

• The guarantor’s financial responsibility is active during the loan term, unlike a security guarantor whose involvement is typically limited to providing collateral.

• This arrangement is less common because it creates a higher level of liability for the guarantor.

Benefits of Guarantor Loans

1. No Deposit Required: Borrowers can secure up to 100% (or more) of the property value without saving for a deposit.

2. Avoid LMI Costs: With the guarantor’s equity covering the shortfall, borrowers avoid the cost of Lenders Mortgage Insurance.

3. Faster Entry into the Market: Helps buyers enter the property market sooner, even with limited savings.

4. Flexibility: Borrowers can combine fixed and variable-rate loans or split loans for tailored repayment options.

Risks for Guarantors

1. Liability: If the borrower defaults, the guarantor is financially responsible for the guaranteed portion of the loan.

2. Property Risk: For security guarantors, their property may be at risk if the borrower cannot meet repayments.

3. Reduced Borrowing Power: The guarantor’s financial commitments may limit their ability to borrow for other purposes.

4. Family Strain: Financial arrangements between family members can sometimes lead to tension or disputes.

How to Exit the Guarantor Role

A guarantor’s obligation isn’t permanent. There are ways to exit the role once the borrower builds equity or financial stability:

• Loan Refinancing: Once the borrower’s LVR drops below 80%, they can refinance to release the guarantor.

• Loan Repayments: Consistent repayments can reduce the debt, allowing the guarantor to be removed sooner.

• Property Value Growth: If the property’s value increases, the LVR may naturally drop, enabling the guarantor’s release.

Steps to Take as a Guarantor

1. Understand the Risks: Ensure you are fully aware of the financial and legal implications of being a guarantor.

2. Seek Professional Advice: Speak with a mortgage broker or financial advisor to evaluate your situation.

3. Check Your Finances: Make sure you can meet your own financial goals even with the guarantor obligations.

4. Set Clear Expectations: Communicate openly with the borrower about responsibilities and plans for releasing the guarantee.

Key Differences: Security Guarantor vs. Servicing Guarantor

Feature	Security Guarantor	Servicing Guarantor
Purpose	Provides equity as collateral	Supports loan repayment requirements
Involvement	Limited to securing part of the loan	May be responsible for loan repayments
Financial Risk	The guarantor’s property may be at risk if the borrower defaults	The guarantor’s income is considered in repayments
Common Usage	First-home buyers to avoid LMI	Less common due to higher financial risk

Guarantor loans can be a powerful tool for helping borrowers achieve homeownership sooner. However, it’s essential for both the borrower and the guarantor to understand their roles and responsibilities fully. Whether acting as a security guarantor or servicing guarantor, clear communication and professional advice are crucial to ensuring a successful outcome for all parties involved.

If you're considering a guarantor loan, speak with a mortgage broker to explore the best options tailored to your needs.