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First home buyers may struggle to build a deposit large enough to satisfy lenders, but a parent or relative may be able to help a person get into the housing market by guaranteeing the loan.
Going guarantor for family or friends can be risky. Protect your interests and relationships by knowing the risks of going guarantor.
A guarantor is a person who guarantees a loan for someone else, usually a family member or friend. The guarantor is legally responsible for paying the other person's debts if the debtor can't pay them.
ASIC’s MoneySmart website1 suggests that before you agree to be a guarantor, think carefully about your own finances, make sure you understand the loan contract, and know the risks.
Seeking independent financial and legal advice is also important and a common requirement of banks or lenders for potential guarantors.
Being a guarantor may be a significant way to help someone you trust purchase a home.
However, it also contains inherent risks to the guarantor, such as being responsible for paying back the entire loan if the borrower can’t.
As well as financial risks, there may also be risks to relationships.
It may be helpful to consider why you are considering going guarantor as well as other options for providing financial assistance.
Considering these questions may be helpful:
What is the underlying goal you are trying to fulfill as a potential guarantor? Consider whether your aim is to help out a family member financially or specifically help them into home ownership.
Are there other ways to achieve the goal? Instead of going guarantor on a loan, could you gift money or loan funds directly?
How could going guarantor impact your own long-term goals such as retirement, government benefits, and/or aged care plans?
How could going guarantor impact your family relationships? Could going guarantor impact family dynamics with other family members?
Benefits of going guarantor are predominantly emotional and tie into achieving the goal you may be trying to fulfil in helping out a family member.
Helping an adult child into a home may be very satisfying for parents. For some people, seeing a child own a home rather than renting may be important emotionally. Others may feel that buying a property is a good financial investment, particularly if they believe that future growth in the asset price will outpace their ability to save a deposit.
While there are no financial benefits for going guarantor, there are benefits for the person you are helping. Being a guarantor for a family member may help them enter the housing market with a smaller deposit or none at all, it may increase their borrowing capacity beyond what they could afford, and it may potentially help them avoid paying thousands of dollars in Lender’s Mortgage Insurance (LMI), which usually applies when a borrower does not have a deposit of at least 20%.
Guarantors take on the financial risk of the loan as well as the risks associated with borrowing money.
“Take the same care as if you were taking out a loan for yourself,” MoneySmart advises.
Impacts on guarantors may include:
If the borrower can't make the loan repayments, the guarantor has to pay back the entire loan amount plus interest and fees. If you can’t pay back the loan, then the lender may will likely repossess the asset you nominated as security, such as your home or other assets as agreed with the loan provider.
If applying for any other loans, you will need to advise of the loans you have acted on as guarantor.
You may struggle to borrow in the future if either you or the borrower couldn’t pay back the guaranteed loan, which could be listed as a default on your credit report.
If you're a guarantor for a friend or family member who can't pay back the loan, it could affect your relationship. It could also have wider impacts on your relationship with other family members or friends.
Being in a position to help a family member with a guarantor arrangement may bring a feeling of satisfaction, but it is really important not to rush in.
It pays to do your homework before agreeing to be a guarantor on a loan.
Seeking financial and legal advice are very important before considering becoming a guarantor or providing a family loan.
It is also a common requirement of banks or lenders that a guarantor receive independent legal advice on guarantee documents.
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1. ASIC, Going guarantor on a loan, accessed 20 September 2020, at www.moneysmart.gov.au
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