If you don’t have a 20% deposit, most lenders will require that you pay the cost of Lenders Mortgage Insurance (LMI). But as home prices rise, the amount you need for that 20% deposit keeps growing.
However, a family security guarantee could help you buy a home using a lower deposit amount and without paying the cost of LMI.
What is a family security guarantee?
Under a family security guarantee, a family member with sufficient equity in their home can use it as a security guarantee for your loan.
The person providing the security is known as the guarantor. The guarantor doesn’t give you or the lender any money. However they will have to accept the obligations associated with entering into a guarantee. And you will still need to make the repayments.
The guarantor’s security doesn’t cover the entire loan amount, just a portion of it. This is usually the amount needed to reduce your loan-to-value ratio (LVR) to 80%. The guarantee is limited to this amount.
If the security guarantee reduces your LVR to 80% you won’t pay Lenders Mortgage Insurance. That means you may be able to reach your deposit saving goal sooner.
How does a family security guarantee work?
Perhaps the easiest way to explain a family security guarantee is to look at an example. For the sake of simplicity we have excluded transaction costs like stamp duty and conveyancing fees that you would need to pay in addition to your deposit.
- Let’s say you want to buy a property worth $500,000.
- You have been assessed and have enough income to service a $500,000 loan.
- You’ve saved $25,000. That’s 5% of the purchase price.
- You need a deposit of 20% (excluding transaction costs) to avoid paying Lenders Mortgage Insurance.
- 20% of the $500,000 lender-assessed value would be $100,000. So you would need to save another $75,000.
- Your parents own a home valued at $800,000.
- They offer $75,000 of the equity in their house as security for your loan.
- You can now borrow the money you need without saving any more (although other credit requirements and restrictions do apply)
- You don’t have to pay the cost of Lenders Mortgage Insurance.
Once your equity in the home reaches 20%, you and your guarantor can apply to the lender to release the guarantor from their obligations and remove the guarantee.
What if you default on your loan?
A family security guarantee is a serious commitment for both you and the guarantor. Before you proceed, you will need to demonstrate to the lender that you can meet the repayments.
If your loan was approved but a change in circumstances meant you couldn’t meet your repayments, the lender has the right to sell the property to recover the loan. If the sale price doesn’t cover the outstanding loan amount, the lender has the legal right to seek the limited guarantee amount from your guarantor.
In the example above, your parents may have to come up with $75,000 to repay the guarantee amount.
Could the guarantor lose their house?
In a worst case scenario where your guarantor was unable to pay, the lender has the right to sell the guarantor’s property to recover the limited guarantee amount.
Understand your obligations
It’s easy to imagine how a scenario like this could create family tensions. So it is important that the borrower and guarantor carefully consider whether a guarantee arrangement would be suitable for them.
It’s very important that both you and your guarantor understand all of the conditions and obligations of a family guarantee before signing. For this reason it is essential that guarantors seek legal advice before entering into any guarantee agreement.
To sum up
- A family guarantee could help you buy a property sooner without paying the cost of Lenders Mortgage Insurance.
- It may help you purchase a home using a deposit below 20% of the lender-assessed value.
- The guarantor offers equity in their property as additional security against your loan.
- Guarantors should seek legal advice and understand their obligations before entering a guarantee.