what-is-a-guarantor-loan
In: Blog

What is a guarantor loan? Is it right for me? How does it work?

 

A guarantor loan could help you to buy your first property without a deposit.

 

But, is it right for you? And will it stand in the way of your financial independence further down the track

 

What is a guarantor loan?

Let’s say you are 18 years old. You have just come out of the probation period of a new job and are earning a regular income. You want to buy your first property but you haven’t been able to save up a deposit.

 

Your parents, on the other hand, have a house that they have paid off. Mum and Dad still have some working life ahead of them and want to help you get started on your property journey.

 

A guarantor loan would allow them to put up their property as collateral, along with the one you want to purchase, in order to cover the deposit amount.

 

This way, you could get finance for the property without needing to raise a cash deposit.

 

How does it work?

Each of you would have to get independent legal advice before executing this strategy.

 

Then, your parents would sign to give you access to their debt-free property to guarantee the deposit component of the loan.

 

Your parents’ property, and the one you are buying, would be cross collateralised, which makes you financially tied to your parents.

 

You would still be able to access whatever first home buyer benefits are applicable as the purchase would be in your name.

 

What implications are involved?

Madhu Ramana, CEO of Zinger Finance, says you should only use a guarantor loan as a last resort.  He says there are many implications involved in this sort of structure.

 

After settlement, your parents will receive information about every credit-related activity you undertake.

 

“Because your parents are guarantor on the debt, they will be exposed to everything you are doing on a credit note,” he says.

 

This means that if you want to release equity further down the track, apply for a credit card or apply for a car loan, they will need to sign off on it.

 

You are basically tied to their hip – they have to give their formal approval on every credit application you make.

 

Another major thing to consider is that, as a guarantor, they are exposed to extra risk. If you are self-employed and come up against major liabilities, they risk facing financial hardship or even losing their house. 

 

If your parents are close to retirement, the arrangement may impact their pension.

 

Who would it suit?

Guarantor loans may be helpful for young adults starting out in their career whose parents own their home outright and are middle aged. Often, it is the parents themselves who guide their grown up child in this direction.

 

Who wouldn’t it suit?

For self-employed people who face liabilities or sporadic income, guarantor loans wouldn’t be a good choice.

 

It also wouldn’t suit anyone, whether they be a borrower or guarantor, who wants to build a property portfolio quickly.

 

Is there a better way to go about it?

Madhu says that while guarantor loans have their place in the world of finance, there are other ways to go about it without tying yourself to your parents.

 

“Should people take out guarantor loans? If that is the only choice, then by all means. At least you’ve now got an extra asset,” he says.

 

“But if there are other choices, then I would say to use that as the last resort.”

 

He compares it to working out at the gym. Let’s say your personal trainer had you doing bench presses – and your parents were sitting on top of the weight.

 

Instead of this heavy arrangement, Madhu says you could work out to a comfortable level without your parents needing to be there.

 

He says if they are prepared to be a guarantor, then they must be confident that you can handle this amount of debt. 

 

“You could also do that in a different way in which you could keep your financial affairs totally independent,” he says.

 

What are your other options?

Instead of being a guarantor, your parents could release equity from their property. Alternitavely, they could get a line of credit, and give this to you to use as a deposit. 

 

Under this arrangement, you would be legally responsible to pay back the loan but your properties wouldn’t be cross-collateralised.

 

Your parent’s property would still be in their name, and your property would be in your name.

 

To do this, you would still need to seek legal and financial advice before drawing up a contract. That contract, however, would be between you and your parents. The bank would not be involved.

 

Madhu says, it is better for each party to stay independent from one another, and reduce the limitations involved.

 

“Keep the structure simple. Keep your lives independent because you never know what life will throw at each one of you,” says Madhu.

 


Disclaimer: Please note that the information given in this video blog is only applicable to a number of scenarios and may not be relevant to your financial situation. For more tailored information regarding your own credit report, we would urge you to seek advice from a professional who is privy to your personal circumstances and can give information specific to your financial situation. Please get in contact with our team if you have any questions regarding your own credit report, or would like any help regarding your own finances.