There are two types of guarantee lending:
1) Security guarantor
2) Servicing guarantor
What is a security guarantor?
A security guarantor uses the equity in their residential property to guarantee a portion of another person’s loan. While this is normally a family member such as a parent or sibling, some lenders will allow extended family members to be a guarantor for the loan.
The guarantor is not required to make any cash payments to the borrower for their deposit. The security guarantee is limited and allows the guarantor to choose the amount to offer as security for the loan. In this way, a guarantor home loan can let first home buyers who may not have a large deposit to buy a place of their own far sooner and reduce or avoid the cost of lenders mortgage insurance (LMI).
When the person signs as a security guarantor, they normally aren’t responsible for paying back the entire loan if the borrower cannot and will not make the repayments. Rather, they’re normally only responsible for the amount they’ve specified in their guarantee if the lender is forced to sell the property. The extent of the guarantor’s potential liability will be outlined in the lender’s loan documents which any guarantor should review and seek professional advice about before committing. The guarantor does not get any direct benefit from the loan but there needs to be an obvious close relationship with the borrowers.
How does a security guarantor loan work?
Let’s say that you want to buy a home costing $500,000. You have saved a deposit of $50,000. That’s 10% of the property’s value. Unless you have a deposit of at least 20% or $100,000 in this example, the lender will ask you to pay LMI. Instead of waiting to save an additional $50,000, a guarantor home loan can offer a solution. We’ll say a guarantor offers $50,000 from the equity in their own home as extra security for your loan. This will give you the 20% security you need to buy the property today without paying LMI. In this way, it’s possible to get a home loan even when you have a small deposit.
NCCP requirements - Security guarantors
Security guarantors are not included in the requirements under the NCCP Act’s responsible lending obligations as the guarantors are not the ‘borrower/applicant’. However, we do recommend the following as best practice:
- Provide guarantors with a copy of your Credit Guide document which provides information about you and your credit assistance services; and
- Recommend in writing that they obtain independent legal and financial advice. This may be a requirement of the lender, however, it’s in your interest to ensure the guarantors have been advised.
What is a Servicing guarantor?
Servicing guarantors are guarantors (most often parents or someone with a close relationship), who agree to help a borrower who has insufficient income to service their loan. The lender will use the guarantor’s income to ensure the loan is affordable and may also use the guarantor’s property as additional security.
NCCP requirements- servicing guarantors
Servicing guarantors are covered by the NCCP Act’s responsible lending obligations. This means the same compliance requirements apply as though they were the borrower - you're providing credit assistance just as you are with the borrowers. As you are providing credit assistance all NCCP Act responsible lending documentation and processes are required to be completed for all loan parties.
ApplyOnline (AOL) submissions
Some lenders will require multiple AOL submissions where there is a guarantee.
Example: A lender requires two applications, one for the 20% covering the equity guarantee and a separate application for the 80% portion. If this is required, you will need to create a second Mercury Opportunity for the guarantee portion alongside the 80% portion to reflect each application.
- Notes and emails should be retained in the first Opportunity as usual but make notes to clearly show the two opportunities are linked.
No additional disclosure documents are required to be prepared for security guarantors; however, you are required to obtain their personal and financial information (and relevant supporting documents) as required by the proposed lender.
It is highly recommended that joint interviews and meetings take place with all applicants and guarantors for the initial meeting. This will help you meet your obligations efficiently and ensure full disclosure with all parties. Then, conduct a face to face meeting with the guarantors separate from the borrowers to ensure the borrowers are not putting any pressure on guarantors.
Always follow up any communication with an email to all parties involved in the transaction and make sure you have discussed the proposed loan arrangement with any guarantors independent of the borrowers they’re helping. Any guarantor should be aware of their obligations under the lender’s credit contract. It’s therefore important to maintain clear and open communication between the applicants and guarantors throughout the loan application process. You should never rely on the applicants to communicate any updates/changes/further requirements to their guarantor so always include all applicants and guarantors in your communications.
Encourage guarantors to seek independent legal and financial advice prior to executing lender and mortgage documentation. This will likely be a lender requirement but be sure to educate your customers and guarantors of this at the outset. Though the lender will require you to sign off that a guarantor has not been pressured into a loan guarantee, you should always have at least one conversation with any guarantors independent of the borrowers they’re helping.