Guarantor loans explained

A guarantee is the form of family help where no money moves and the most is at stake. The parents' property becomes extra security for the child's loan; the child borrows more than the deposit alone would allow, usually without paying lenders mortgage insurance; and the parents carry a liability that lasts until the lender releases it. Understanding exactly what is guaranteed, and what is not, is the whole subject.

Security guarantee or servicing guarantee

Almost every family guarantee written today is a security guarantee. The guarantor offers their property as security for part of the loan; they do not promise to make the repayments and their income is not used to qualify the borrower. The borrower has to service the whole loan on their own income.

A servicing guarantee, where the guarantor's income is counted to get the loan approved, is rare now. Where it exists the guarantor is exposed to the whole loan and to the repayments, which is a different and larger commitment. If a lender proposes one, the word to look for on the paperwork is which kind it is.

The limited guarantee

Lenders commonly cap a family guarantee at the part of the loan that sits above 80% of the price, plus sometimes the purchase costs. That cap is the limited guarantee. It matters because it is the most the guarantor can be asked for; it is not the whole loan. On a purchase where the deposit is 10%, the limited guarantee is roughly the 10% needed to bring the lender's exposure to 80%, and the family-help planner works the figure out for any price and deposit.

The guarantee is secured by a mortgage over the guarantor's property. If that property already has a loan on it, the lender looks at the equity left after that loan. Some lenders will not take a guarantee from a guarantor who is retired, has no income of their own, or whose only asset is the home they live in; policies differ and a broker will know which.

When the guarantee is released

The guarantee usually comes off once the loan is at or below 80% of the property's value. That happens two ways: the borrower pays the loan down, or the property's value rises and the lender's valuer finds the ratio has fallen. Most families see the release come from a mix of the two. The release is not automatic; the borrower applies, the lender's valuer values the property, and the lender discharges the guarantor's mortgage. Until then the guarantor's property carries the mortgage and, in practice, cannot be sold or refinanced without the lender's involvement.

The planner shows how long repayments alone take to bring a loan under the 80% line at a given rate. It ignores value changes on purpose, because no one knows them in advance; a rising market shortens the wait and a falling one lengthens it.

If repayments stop

If the borrower defaults, the lender's first recourse is the property that was bought. If selling it does not cover the loan, the lender can call on the guarantor for the guaranteed amount, and if the guarantor cannot pay, it can enforce its mortgage over the guarantor's property. That is the worst case and it is rare, but it is the case the guarantee exists for, and it is why lenders commonly require the guarantor to get independent legal advice before signing, and why the Banking Code of Practice gives guarantors information rights and time to consider before they do. The paperwork will also say whether the guarantor can withdraw before the loan is drawn, and what notice the lender must give the guarantor if the borrower falls behind.

What the guarantor is agreeing to, in plain terms

• To let the lender register a mortgage over their property for a stated amount.
• To pay up to that amount if the borrower cannot and the bought property does not cover the loan.
• To keep their own property encumbered, with limits on selling or refinancing, until the lender releases the guarantee.
• To disclose their position honestly to the lender, and, commonly, to see their own solicitor first.

What they are not agreeing to, under a security guarantee, is to make the repayments, or to owe more than the cap.

Questions worth asking before signing

1. Is this a security guarantee or a servicing guarantee, and what exactly is the capped amount?
2. What is the release condition in writing, and who pays the lender's valuer when the time comes?
3. What happens to the guarantee if the guarantor wants to sell or refinance their own property first?
4. What notice does the lender give the guarantor if the borrower misses payments?
5. Does the guarantee affect the guarantor's own borrowing, pension or estate plans? An accountant or adviser answers that side; the lender does not.

None of these is a reason for or against. They are the terms of the arrangement, and both generations are better off reading them before the day of settlement than after it.