1. Introduction
In easy words, a mortgage guarantor is someone who assists people getting a mortgage, just in case they will not be granted in their own capacity.
As a safety financial net, the guarantor pledges to pay off the mortgage in case the primary borrower defaults or fails to pay it. This can be especially helpful to first-time homebuyers, the self-employed, and anyone with a low or unstable credit history.
But what being a mortgage guarantor entails is a huge responsibility and significant risk. In this article, we are going to dig deeper into who a guarantor is, his responsibilities, potential risks, and how they should protect themselves while undertaking this financial commitment.
2. What Is a Mortgage Guarantor?
A mortgage guarantor is simply an individual who is ready to step up and take over the obligation to repay the mortgage loan of the primary borrower in case that person cannot.
It is typically a family member or friend, but really anyone can, depending on the agreement between the parties, as this additional security can often advance a mortgage’s loan approval from the lender to a borrower who would otherwise not qualify for it.
A guarantor and a co-signer represent an important distinction. A co-signer signs on the first mortgage agreement thus having equal liability with the borrower over repayment purposes since the very first day, while having rights equal to the buyer’s.
A guarantor only steps in when the borrower is unable to repay the money borrowed; the latter does not have rights over the property.
This means that the agreement of the guarantor is just a financial backup without any active financial liability since day one.
3. Why do an individual need a mortgage guarantor?
Some borrowers may not be able to get a mortgage or be unable to get the best deal due to a slight bad credit record, hence looking for a guarantor.
Here are some of the usual situations why a guarantor may be useful:
First-Time Homebuyers with an Unestablished Credit History: Young or first-time buyers may have little or no credit history, which makes them not be up to the lenders’ standards.
It becomes easier to get a mortgage with a guarantor who can prove that he would be in a position to pay the loan if the buyer cannot meet their repayment term.
Self-employed with irregular income: For most cases, the borrower is self-employed, and thus he or she would have his or her income flows non-uniform.
This scares lenders from providing a mortgage to such applicants. A guarantor may increase chances for such applicants.
Low and irregular income earners: The low income earners may not fulfill the strict requirements of lenders in regards to income.
A guarantor could improve a mortgage application by a stable income or providing security based on finances.
Having a guarantor increases the possibility of getting a mortgage and even lets one get better interest rates or terms since, with a guarantor, the risk for the lender is much decreased.
4. Important Duties of a Mortgage Guarantor
Being a mortgage guarantor is definitely not something that a person should take lightly, as having a mortgage approval a guarantor puts many important responsibilities squarely on one’s shoulders:
Financial Responsibility
The primary role of a guarantor is to assume mortgage back payments if the borrower when there is a failure to pay. That is, in case of failure to make a specific payment by the borrower, the lender may call for the amount from the guarantor.
In the worst-case outcome, the guarantor could be required to repay all the outstanding loan balance.
Legal Obligation
If a guarantor signs a mortgage contract, he commits himself under a legally binding agreement. A legally binding obligation means the guarantor, like the primary borrower, will be liable for the loan.
The commitment ends either when the guarantor mortgage amount is wholly paid off, or the guarantor is officially out of the deal, which might be pretty hard.
Credit Impact
Risk to lender: the guarantor’s credit score would be affected negatively in case the borrower is not paying his loan as agreed or defaults the same.
The missed loan payments would reflect on the credit report of the guarantor; therefore, their credit score would decrease and impact the ability to access loans in the future.
Support at Application Stage
The lender may also ask the guarantor to present some form of evidence regarding his financial stability.
These may include income statements, credit reports, and documentation regarding his assets. This will enable the guarantor mortgages the lender to be sure that the guarantor can comply with their obligation if the borrower cannot pay.
5. Risks Connected to Mortgage Guarantors
While acting as a loan guarantor for your dear one to acquire a dream home may be more than rewarding, it is an exposure involving high risk. At least five risks a mortgage guarantor may expose himself to.
Financial Risk
The most obvious risk is financial exposure in the event that the borrower defaults. Guarantors will be left with financial stress in the event of missed payments, which will come at the wrong time especially if they were not prepared to pay for such unexpected expenses.
Credit Score Implications
Even one missed mortgage payment by the borrower can set off a chain reaction payment defaults, often hurting the guarantor’s credit score. This may take years to recover and even until then deny the guarantor access to credit or loans.
Liability
In case the debtor is unable to pay back the money when there is a default, the creditor will take the guarantor to court. This may eventually result in an asset seizure or wage garnishment depending on the terms and conditions of the loan agreement.
Long-Term Commitment
Becoming a guarantor for auto loan will also decrease your borrowing capacity.
Commitment from the guarantor is considered in the debt-to-income ratio, which will shrink the room for future loans or mortgages from the guarantor.
6. How Guarantors Can Protect Themselves
Because the risks are great, guarantors must also take precautions to protect themselves:
Knowing the Borrower’s Financial Condition
Before becoming a guarantor, you need to meticulously evaluate the borrower’s solidity and his plans regarding debt repayment and the income to be generated for servicing his mortgage.
Setting Boundaries and Expectations
Mortgage payment discussion clearly sets expectations with the borrower, including regular check-ins in relation to their financial situation and challenges to monthly payments that might arise.
Legal Advice
Talking to an attorney will help you understand the guarantor agreement as well as the consequences arising out of that.
A lawyer can study the agreement and highlight clauses that are more likely to bring loss or risk.
Checking on the Loan
The guarantors can get access to the payment records of the mortgage.
If the borrower fails to make timely payments to pay the mortgage then the guarantor comes to know much before the situation gets worse as soon as the borrower fails to pay the missed payments.
Alternatives to Being a Mortgage Guarantor
If the risks of acting as a guarantor are too high, there are alternatives that can still help support the borrower:
Gifted Down Payment
As an alternative to becoming a guarantor, one might opt for giving the down payment as a gift to the borrower.
A gifted down payment will serve to decrease the loan amount and improve the loan-to-value ratio, which means the borrower might just get better mortgage terms without having had to sign any legally binding mortgage documents themselves.
Co-Signer Option
For those who are not uncomfortable sharing financial responsibility but want some form of ownership, co-signing might be the better bet.
A co-signer is a joint borrower; they are liable and own the property equally to the primary borrower. Guarantors do not own assets.
Alternative Lenders
If the borrower is not suited for conventional lenders, then alternative lending is available to them.
Alternative lenders include credit unions, online lenders, or specialist mortgage brokers. These lenders allow for greater flexibility and often accept borrowers with little income or no credit scores.
Conclusion
Becoming a mortgage guarantor is a big responsibility that should be undertaken with much caution. Even though it helps someone in securing their mortgage, it comes with financial, legal, and credit risks to the guarantor.
Such guarantors should ensure that they take responsibility for themselves, evaluate the stability of the borrower’s finances, and seek advice from lawyers before giving them their guarantee.
Alternatives like gifted down payments or co-signing could also give out the same amount of help but with lesser risks. If becoming a guarantor is a decision you are considering or if you’re looking into any other alternatives, you should not hesitate to get advice from a mortgage broker or lender that can guide you along the best way.
