Mortgage guarantees are a great way to get into the property market early. Not only do they reduce the need for a sometimes arduous battle to get a 10% or 20% deposit on a property, but they may also enable a purchaser to borrow the full purchase price of a property making the journey to home ownership a little easier.
However, the realm of guarantees generally and especially mortgage guarantees do come with associated risks which mean that navigating this path can be aided by legal professionals who are capable of guiding you through this potentially risk-laden avenue to property ownership.
What is a Mortgage Guarantee?
A mortgage guarantee is when someone, most commonly a family member, provides you with security on top of the deposit amount which you already possess for your home loan. A lender may permit the guarantor to be an extended family member, but this will vary between lenders.
The security in question is usually the equity which the guarantor holds in their own home and consists of the difference between the market value of the property they own and the amount you owe over your own home loan. In offering up their home equity, a guarantor enables the borrower to enter the property market sooner.
Benefits of a Mortgage Guarantee
The central benefit to having a guarantor on your mortgage, aside from earlier exposure to the property market, is the ability to avoid the need to pay lender’s mortgage insurance (‘LMI’). LMI is a policy that the purchaser pays to their lender to protect the lender from borrowers who cannot meet loan repayments.
In order to avert LMI normally, you will need to provide 20% of the purchase price of the property which can take extra time to accrue on top of the need to pay for Stamp Duty and other costs if you are not eligible for a first home buyer scheme. A guarantor can expedite the process by providing security for some or all of the amount needed to attain 20% of the price, to reduce the loan to valuation ratio.
Risk of a Mortgage Guarantee and Expert Legal Mitigation
The primary risk to being a guarantor is that you will become responsible for paying back the loan if the purchaser is unable to meet their loan repayments. As this risk is substantial, considering both your legal and financial position in relation to withstanding an unexpected need to start making loan repayments after a default is a wise decision.
There are several risks for the guarantor to consider which arise from the default of a borrower and the need for the guarantor to step in.
- Credit Rating: Although your credit rating is not necessarily impacted by becoming a guarantor, it will become affected where the borrower defaults. If you are then unable to fulfill the loan repayments, you will have an affected credit rating.
- Relationship Issues: The reason why lenders require a guarantor to be an immediate relative such as a parent is because of the fact that there is a potential for the relationship collapsing in the event of a guarantor needing to repay the loan, especially in circumstances where the guarantor is unable to pay at that time.
- Applying for Credit: Applying for credit on your own as a guarantor means that your lender will be looking at the mortgage for which you act as guarantor. Because your role as guarantor is considered a liability, lenders may be cautious in granting you additional credit.
It is because of these things that you must consider carefully the risks of being a guarantor, mitigation strategies and your legal and financial position.
Risk Mitigation
There are several things you can do to ensure that you are protected emotionally, legally and financially when becoming a guarantor. These include:
- Business Transaction: Treat the role of acting as a guarantor for your close relative as a business transaction. Were this an ordinary transaction between two business people, independent legal advice would be sought as to the quantum of risk, and you will want a legal expert to explain any contracts to you before signing as guarantor.
- Forward Thinking: Ensure you can actually afford to repay the loan in the event the borrower becomes unable due to illness or loss of employment or any other reason which may cause a default.
- Gifts: Asking for a guarantor may not be the correct or even appropriate means by which you can achieve home ownership. Some lenders may permit a gift to be given by one family member to another to cover the deposit. Not only does the borrower receive their deposit sooner but the gift giver is not locked in as the gift is simply a one-off payment to cover the loan.
Acting as a guarantor is not a lifetime affair and you can ask to be released from this obligation and this usually happens 2 – 5 years after the loan was set up, depending on your arrangement with the lender. Ultimately, seeking legal advice from a renowned source will be key to understanding how your particular circumstances will be affected by a guarantor loan.
How Burgess Thomson Can Help
The team at Burgess Thomson has substantial expertise in Business, Commercial and Property Law. With over 60 years’ combined experience, our solicitors have successfully assisted many clients from start to finish. We are known for sound advice and our ability to comprehensively answer any questions in our area with utmost diligence.
If you need independent legal advice for guarantors, or wish to discuss your matter with our team, please do not hesitate to contact our office on (02) 4929 5602 to arrange an appointment.
