How Does a Guarantor Loan Work?
A guarantor loan uses your family member's property equity as additional security, allowing you to borrow more than 80% of the property value without paying LMI. In a family guarantee arrangement, the guarantor provides a limited guarantee over a portion of your loan, typically the amount needed to bring your effective loan-to-value ratio (LVR) down to 80%. No cash changes hands and the guarantor does not make repayments on your loan.
Here is how the process works step by step:
1. You apply for a home loan with a deposit smaller than 20%.
2. Your guarantor (usually a parent) agrees to use equity in their property as additional security.
3. The lender places a limited security (a second mortgage or caveat) over the guarantor's property for the guaranteed amount.
4. You receive the full loan without paying LMI, because the combined security (your property plus the guarantee) covers the lender's risk.
5. Once your own equity reaches 80% of the property value, you apply to have the guarantee released.
Example: You are buying a property for $600,000 with a $30,000 deposit (5%). To avoid LMI you need 20% equity, which is $120,000. You are $90,000 short. Your parent provides a limited guarantee for $90,000 against their own property. The lender now has security for the full amount and does not require LMI. Your parent has not given you any money, and you make all repayments yourself.
How Much Can a Guarantor Help You Save?
A guarantor can save you between $8,000 and $35,000 in LMI costs depending on the property price and your deposit size. The table below shows indicative LMI savings when using a guarantor to avoid the premium entirely.
| Property Price | Your Deposit | LMI Without Guarantor | LMI With Guarantor | Saving |
|---|---|---|---|---|
| $500,000 | 5% ($25,000) | $16,000 - $22,000 | $0 | $16,000 - $22,000 |
| $600,000 | 5% ($30,000) | $20,000 - $28,000 | $0 | $20,000 - $28,000 |
| $750,000 | 10% ($75,000) | $12,000 - $18,000 | $0 | $12,000 - $18,000 |
| $1,000,000 | 10% ($100,000) | $22,000 - $35,000 | $0 | $22,000 - $35,000 |
These figures are indicative and vary by lender and LMI insurer. The true cost of LMI is even higher when capitalised onto the loan, as you pay interest on the premium for the life of the loan.
Who Can Be a Guarantor?
Parents are the most common guarantors, but siblings, grandparents and in some cases de facto partners may also be accepted depending on the lender. Most lenders restrict guarantors to immediate family members. The specific requirements vary, but generally a guarantor must:
- Own residential property with sufficient equity to cover the guaranteed amount
- Demonstrate the ability to service their own existing debts (the lender will assess the guarantor's financial position)
- Obtain independent legal advice before signing the guarantee (this is mandatory with most lenders)
- Not be in financial hardship or have a poor credit history
Some lenders accept grandparents as guarantors, though age limits may apply. Siblings are accepted by a smaller number of lenders. Friends and extended family members are generally not accepted. If your intended guarantor does not meet the criteria of one lender, a broker can check other lenders on their panel, as policies vary significantly.
What Are the Risks for the Guarantor?
The primary risk is that the guarantor's property could be used to recover losses if the borrower defaults on the loan. While guarantor loans are generally safe when structured as limited guarantees, there are real risks that both parties should understand:
- If the borrower defaults and the property is sold for less than the loan balance, the lender can call on the guarantee and potentially force the sale of the guarantor's property to recover the shortfall.
- The guarantee may reduce the guarantor's own borrowing capacity, as lenders factor the guaranteed amount into their debt-to-income calculations.
- The guarantor cannot easily sell or refinance their own property while the guarantee is in place, as the lender holds a security interest over it.
Most lenders offer LIMITED guarantees, meaning the guarantor is only liable for a portion (typically 20% of the purchase price), not the entire loan. This significantly reduces the guarantor's exposure. Always confirm that your guarantee is limited, not unlimited, before proceeding.
How to Remove a Guarantor (Exit Strategy)
You can remove the guarantor once your own equity in the property reaches 80% of the current property value, which typically takes two to five years. The process to release a guarantee is straightforward once you meet the requirements:
1. Request a property valuation from your lender (some lenders allow desktop valuations, others require a full valuation).
2. If your remaining loan balance is 80% or less of the current property value, apply to your lender to release the guarantee.
3. The lender removes the security from the guarantor's property and discharges the guarantee.
4. There is generally no cost to release the guarantee if your LVR is under 80%.
Your equity can grow through a combination of regular repayments, additional lump sum payments, and natural property value growth. In a market where property values are growing at 5% per year, a property purchased for $600,000 could be valued at $660,000 after two years, helping you reach the 80% LVR threshold sooner.
It is important to set an exit timeline at the outset. Both the borrower and guarantor should agree on a target date for releasing the guarantee, and the borrower should make every effort to reach 80% equity as quickly as possible.
Guarantor Loan Requirements
Both the borrower and the guarantor must meet specific eligibility requirements, including income, credit and legal advice obligations.
| Requirement | Borrower | Guarantor |
|---|---|---|
| Income | Must demonstrate ability to service the full loan | Must be able to service own existing debts |
| Credit history | Clean credit required (no defaults) | Generally clean credit required |
| Property | Purchasing residential property | Must own property with sufficient equity |
| Legal advice | Recommended | Mandatory (independent legal advice) |
| Age limits | Standard lending age limits apply | Some lenders cap guarantor age (e.g. under 65-70) |
| Existing debts | Factored into serviceability assessment | Guarantee amount may reduce borrowing capacity |
Guarantor Loans vs Other Low-Deposit Options
A guarantor loan is one of several ways to buy with less than 20% deposit, each with different eligibility requirements and trade-offs.
| Option | Min Deposit | LMI | Eligibility | Key Condition |
|---|---|---|---|---|
| Guarantor loan | 0-5% | None | Need eligible family member with property | Guarantor's property used as security |
| First Home Guarantee | 5% | None | First home buyers, property price caps | Government guarantees the gap |
| Pay LMI | 5% | $8,000 - $35,000+ | Open to all borrowers | Premium added to loan balance |
| Save 20% deposit | 20% | None | Open to all borrowers | Requires significant savings and time |
Common Mistakes with Guarantor Loans
Most issues with guarantor loans arise from poor planning, unclear expectations or insufficient professional advice. Avoid these common mistakes:
1. Not setting an exit timeline. Both parties should agree on a target date for releasing the guarantee. Without a plan, guarantors can remain on the hook for much longer than expected, creating tension and limiting their own financial options.
2. The guarantor not getting independent legal advice. This is mandatory with most lenders but some guarantors treat it as a formality. A solicitor will explain the real risks in plain language, ensuring the guarantor understands what they are agreeing to.
3. Borrowing at maximum capacity. Just because a guarantor allows you to borrow more does not mean you should. Stretching your budget to the absolute limit leaves no buffer for interest rate rises, changes in income or unexpected expenses.
4. Not understanding limited vs unlimited guarantees. A limited guarantee caps the guarantor's liability to a set amount (usually 20% of the purchase price). An unlimited guarantee makes the guarantor liable for the entire loan. Always confirm the guarantee type in writing before proceeding.
5. Assuming the guarantor has no ongoing obligations. While the guarantor does not make repayments, their borrowing capacity may be reduced for the duration of the guarantee, and they may face restrictions on selling or refinancing their own property.
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