Having your parents act as a rent guarantor can make it much easier to buy a property with a small deposit. For many reasons, it isn’t an option for everyone. You need to be fortunate enough to have parents who own their own home and are willing to help you out.
If this is an option you are considering then you need to understand how going guarantor works and the risks involved. This will make it easier when you ask them for help.
How a home loan guarantee works
A home loan guarantor agrees to use their property as security if a borrower can’t repay their loan. In other words, if the borrower can’t repay their loan the guarantor could become liable for the debt.
If you have a small deposit and your home loan application isn’t very strong, having a parental guarantor can reassure your lender and boost your chances of success. But if you can’t repay the debt your parents might have to repay it and even sell their property in the worst outcome.
That’s what makes a home loan guarantor risky.
A major benefit of having a guarantor is avoiding lenders mortgage insurance (LMI). Lenders require borrowers to pay an LMI premium if their deposit is less than 20% of a property’s value. LMI can cost thousands or even tens of thousands depending on your loan amount and deposit size.
Let’s say you want to buy a $600,000 apartment and you only have a 5% deposit saved. That’s $30,000. According to insurer Genworth’s LMI premium estimator, your LMI would cost you $23,954.
But if your parents agreed to guarantee a further 15% of the property’s value (that’s $90,000) your lender would consider your loan to value ratio (your deposit size versus the property’s value) to be 20%. You’d still need to borrow 95% of the property’s cost, but your lender won’t charge you LMI on top. That’s because having a guarantor reduces your lender’s risks.
In this scenario, your parents’ home is on the line if you can’t repay your loan early on. But once you’ve repaid that first $90,000 of the loan amount (the 15% portion they guaranteed) then they’re off the hook. The rest is up to you.
What to check before you ask
Before asking your parents to go guarantor you should answer the following questions as best you can:
1. Do your parents own a property?
If your parents are renting and don’t own a property then they can’t act as guarantor. The lender needs a property that someone actually owns to secure the loan.
2. Can you really afford this home loan?
Use a loan repayment calculator to work out how much your home loan repayments will cost each month. Then take a long look at your monthly income and expenses. If you can’t afford the repayments or think it will be a struggle then you should rethink asking your parents to put their home at risk.
3. What will you do if interest rates rise?
Home loan rates are at record lows right now. But that can’t last forever. Recalculate your home loan repayments with a higher rate and see if you can still afford it. If you’re looking at a home loan with a 2.5% interest rate, imagine it’s now 4.5%. Can you still afford the repayments?
4. Do you have a strong relationship with your parents?
Finances and family are potentially a damaging combination. If you’re worried that tying your finances into your parents’ finances with a guarantor arrangement will cause trouble, then it’s probably not worth it. But if you are confident you can handle the debt, have your parents’ trust and everyone understands the risks involved then there’s less to worry about.
How to ask your parents
You hopefully know your parents well enough to understand the best way to approach the subject of going guarantor.
Sitting your parents down and explaining the guarantor process might work for some people. For others, you may want to raise the subject of guarantors and gauge their response before asking them straight out.
You could mention you’re looking at properties and speaking to lenders or a broker. Then casually mention how your lender told you about guarantors.
However you ask them, the best thing is to make it clear that you’d like your parents’ help, but be equally clear that they can say no. Going guarantor is a big ask and it’s not without risks. Make it an open-ended question or discussion at first.
If they are interested, take the time to explain how the guarantor process works as best you can. Get them to talk to your lending specialist or mortgage broker. And they will also need to get independent financial advice before going guarantor. It’s a good idea to mention that as a way to reassure them.
Asking your parents to go guarantor is a big step and it isn’t the right move for everyone. But if you approach the situation carefully it doesn’t hurt to ask.
