With the cost of New Zealand property at an all-time high, many prospective first home buyers struggle to save a big enough deposit to enter the property market. One way around this issue is to have a family member be guarantor, using their own home as security for the borrower’s loan or for their deposit. But before agreeing to be a guarantor, it’s important to understand what the pros and cons are.
Getting help from a family member could mean the difference between buying a first home now or having to wait several years while saving a bigger deposit or increasing earnings. And for borrowers with no credit history or bad credit issues, having a family member be guarantor could help get loan approval over the line.
A guarantor is someone – usually a family member – who commits to being a back-up for someone else’s loan – either for the full loan amount or for the deposit. Most often, the guarantor will use their own assets – such as the family home or an investment property – as collateral for the loan. Should the borrower stop repaying the loan, the lender may recover the loan from the guarantor.
While being guarantor could help a borrower into their own home sooner, being a guarantor is a serious decision as guarantors face a real threat of losing their own home if the borrower fails to repay the loan.
Pros and Cons
Pros for the borrower:
- Help getting onto the property ladder – for first home buyers struggling to save a big enough deposit, or for those who don’t meet lending requirements, having a guarantor could be the step up needed to buy a first home.
- Increased borrowing capacity – with a guarantor, some lenders may view a borrower’s application as a lower risk and be more inclined to lend, or they may lend a higher amount.
- Buy without a deposit – if a guarantor guarantees the deposit, a borrower may be able to buy a first home without waiting until they’ve saved a big enough deposit. Most lenders will require proof that at least 5 per cent of the borrower’s deposit comes from their own savings.
- Avoid lender’s mortgage insurance or a low equity margin – borrowers with less than a 20 per cent deposit may be able to avoid being charged a low equity margin or having to pay lender’s mortgage insurance, charged by the lender to cover perceived risk for borrowers with low deposits.
Cons for the guarantor:
- A long-term commitment – being locked into someone else’s loan as a guarantor could impact your own financial situation in the long-term. It may be possible to refinance the loan once the borrower has paid back more than 20 per cent equity to remove the guarantor from the loan.
- Risk to your credit score – if things go wrong and the borrower defaults or misses repayments on their loan, being a guarantor could negatively impact your credit score resulting in your own future loan applications being turned down.
- Lose your home – If the worst happens and the borrower defaults, there’s a real chance your own home may need to be sold to repay the loan.
- Strained relationships – guaranteeing someone else’s loan is a huge financial commitment, that has the potential to strain family relationships if things go wrong.
To guarantor or not
For many first home buyers, having a guarantor is sometimes the only option to buying a first home. And while the benefits for the borrower may be obvious, for the guarantor there is significant risk. Before deciding to be a guarantor, it’s important to seek sound legal and financial advice and to make sensible decisions with your own financial future in mind.
If you’re looking to help your children buy a first home, talk to a Mortgage Express branded adviser about your options. We can take you through the process of guaranteeing someone’s loan and help you decide if being a guarantor is the right option for you.