What is a Guarantor?
A guarantor is someone who promises to pay another person’s loan or debt if the person will not be able to pay the said obligation.
Many lenders now allow a related third party to offer additional security to help a family member get a loan for any purpose. The third party or person providing this support is known as a guarantor.
Being a guarantor is not the same to being a co-signer or a co-applicant. A co-applicant is included in the loan and will be held responsible for the entire amount of the loan until it is paid in full. On the other hand, a guarantor is only associated to a loan by a guarantee. This guarantee can be released and the guarantor’s responsibility stopped, even if the loan is not fully paid.
How Does This Work?
Basically, the guarantor agrees that his own property will be used as additional security for the borrower’s loan. This has to be made clear: the main security for the loan will be the borrower’s property. The lender will also obtain a mortgage over the guarantor’s property. This mortgage will be used to support a guarantee from the guarantor.
Who qualifies as guarantors?
Guarantors are restricted to immediate family members only. By and large, this is limited only to parents, but guarantors can also include siblings and grandparents. Some lenders now allow extended family members, even ex-spouses, to serve as guarantors to a loan.
What will happen to the guarantor if the borrower fails to meet his obligations?
When this happens, the lender may take legal action, normally first against the borrower, and in extreme cases against the guarantor. The guarantor will then be legally responsible for the amount specified in the guarantee.
Any person who is being asked to become a guarantor for a property loan is advised to seek legal and financial advice first before accepting such a responsibility. There are other considerations that would-be guarantors should take into account. Remember that once you become a guarantor to someone else’s loan, your ability to borrow will be reduced consequently.
In what ways will the guarantor help the loan application?
With the backing of a guarantor, the borrower may now be able to access the full purchase price and sometimes even the other costs related with the purchase of the property. This may differ from lender to lender. Some lenders may demand that borrowers contribute some of their own equity, even if there is a guarantor.
Another plus of having a guarantor is that the borrower may save hundreds or even thousands of dollars by evading Lenders Mortgage Insurance (LMI). Normally, LMI is obligatory for home loans when the loan is larger than 80% of the total worth of the property. LMI is a form of insurance which lenders take out to cover the added risk of high Loan to Value Ratio (LVR) lending. Even though this insurance covers the lender against borrowers who fail to pay their obligations, it is the borrower who pays the premium.
The guarantee amount is dependent on the policy of the lender. It can vary from the full loan amount to as low as 20% of the loan. When the borrower has built up equity in their property, the guarantor can then apply for a release from the loan.
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