Have You Been Asked To Act As A Guarantor?
It is human nature to want to help others and in particular family but before you commit to acting as a guarantor you need to understand and be comfortable with the risks of going guarantor for someone.
Often banks, finance companies and other lenders will allow a person (as a related third party) to provide additional security to assist another person (generally a family member) to buy their own home, a vehicle or a loan for almost any other purpose.
The person providing this is known as a guarantor.
The practice of using a guarantor has become quite common with first home buyers in Auckland where prices are often higher meaning it is harder to save a deposit.
Generally it is the parents helping their children (and spouse) but the reverse is also common now and especially where the parents may have had a previous business failure or had a marriage break-up meaning they are starting again financially.
Understanding the Risks of Going Guarantor
Before you step in and act as a guarantor for anyone you should understand the risks of going guarantor and have explained the document which you are actually signing.
Unfortunately the bank staff who often suggest people act as guarantors are not very good at explaining the risks associated with acting as a guarantor. Many guarantors (often parents) only read the fine print when it is too late – that is when something has gone wrong with the loan and the parents guarantee is called upon.
Saying “I didn’t understand” is not going to be a defence as there is plenty of information around if you really want to find it;
- Consumer Affairs has information published on their website – CLICK HERE
- The Citizens Advice Bureau also has information published – CLICK HERE
Personally I also like many of the articles written by Diana Clement, and you can CLICK HERE to read an article she wrote that was published in the NZ Herald. You are also welcome to contact myself or any of the advisers at North West Mortgages.
Unlimited Guarantees Are Quite Common
A major risk that very few people are aware of is that often the guarantees have no limitation.
The guarantor may think they are just signing up to guarantee the home loan (‘say’ $250,000) but in fact they are signing up to the home loan and any subsequent borrowing or liabilities that the borrower may enter into.
Additional borrowing that the guarantor may end up being liable for can include future increases to the mortgage, any overdraft facilities, personal loans, credit cards and even extend to business loans etc. The total borrowing can soon increase to significantly more than the original amount.
Most banks documentation has both borrowers and guarantors signing up to unlimited guarantees unless an alternative is specifically requested. Even if at the outset you have limits set, it is quite common to find that at a later date the borrowers and guarantors have signed an unlimited guarantee.
The Definition of ‘Guarantor’
A person who guarantees to pay for someone else’s debt if he or she should default on a loan obligation.
This means the bank will be asking the guarantor to take over the debt including any arrears and penalties if the borrower has not keep the payments up to date or for any other reason that concerns the bank or lender and triggers them to call up the loan.
Lenders treat anyone that has offered to guarantee a loan as a liable party and will enforce collection if required.
Guarantor versus Co-Borrower
Being a guarantor is different to being a co-borrower, co-applicant or co-signer.
Generally a co-borrower, co-applicant or co-signer will be included on the loan and will be responsible for the entire loan until such time as it is repaid in full. They also often have a financial interest in the asset (property) that is being used to secure the loan.
A guarantor is linked to a loan by a guarantee.
One advantage is that this guarantee can be released by the bank or lender at any point without the loan having to be repaid in full. Getting the bank or lender to actually release the guarantee may not always be as easy as it appeared at the outset of the loan as technically you are asking the bank or lender to reduce their level of security – something that no bank or lender really wants to do.
Sometimes the banks and lenders may agree to a limited guarantee. This means the guarantor’s exposure may be limited to a specific amount or for a specific timeframe. This is defiantly a better option as it limits the potential loss and/or agrees at the outset for the guarantee to cease after a pre-determined length of time.
When the guarantee is released the guarantor’s responsibility ceases.
How does it work?
A guarantor generally allows the equity in his or her own property to be used as additional security for the borrower’s loan.
The primary security for the loan will still be the borrower’s property but the lender will also take a personal guarantee or a mortgage over the guarantor’s property. This mortgage will not support the loan directly but will used to support a guarantee from the guarantor.
The borrower will generally receive all communication from the bank or lender regarding the loan unless the loan goes into a default situation when the guarantor will be sent notice to ensure they are made aware of their responsibility as a guarantor.
Who can be a Guarantor?
With home loans guarantors are generally limited to immediate family members.
Normally, this would be a parent but guarantors can include siblings and grandparents. Some banks and many other lenders will allow extended family members and even ex-spouses to be a guarantor to a loan especially where a mortgage is being refinanced after a separation.
How will having a guarantor help the loan application?
Having a guarantor may allow home buyers and especially first home buyers who have insufficient deposit to meet the bank criteria for the purchase of a home or a vehicle.
The borrowers must still have the ability to make the loan repayments as per the criteria required by the bank or lender.
Saving a deposit can be the most daunting aspect for many purchasers and it can be very hard to do when you are also paying rent. By having a guarantor, the borrower may be able to borrow the full purchase price and sometimes even the costs associated with purchasing property.
Another of the main benefits of having a guarantor for a property loan is that the borrower may save money by avoiding Lenders Mortgage Insurance (LMI). Generally LMI is required for home loans where the loan is greater than 80% of the value of the property.
Seek Advice Before You Agree To Sign Any Loan Guarantee
If the borrower is unable to pay back the loan according to the terms of the contract, the lender can take legal action against the borrower, and in some circumstances, the guarantor. The guarantor may be liable for the amount of the loan secured by their property, or the entire loan amount, depending on the terms of the guarantee.
It is not a small responsibility to act as a guarantor for someone and anyone who is considering being a guarantor is advised to seek independent legal advice before accepting the role of guarantor.
The advice will almost certainly be NOT to act as a guarantor; however many people will accept the risks of being a guarantor for family.
It Really Can All Go Wrong!
Just as none of us can predict our own future, it is even harder to know what is in store for others.
There are a number of issues that may cause a person to default on a loan and often these issues are not apparent when the guarantor agrees to act for the borrowers.
Some of the more common issues that cause loan defaults are; marriage break ups, business failure, redundancy, illness including depression, and drug or alcohol dependency.
Insisting on the correct insurance may save financial loss from some of these issues, but not all of them are insurable risks.
Solicitors and mortgage brokers will almost certainly have stories of clients who have acted as guarantors and had the guarantee called up due to some of these issues.
Having a Mortgage Protection Insurance will offer some help but there are still some things that you cannot insure against.
Speak To Your Mortgage Broker Or Other Professional Adviser
The best advice is to proceed with caution and only if you are 100% happy to act as a guarantor.
When you speak to your mortgage broker ask them to explain all of your options. You may be better to borrow the money yourself and then lend it to you son or daughter (or friend or associate) rather than put your home and your credit rating at risk.
A mortgage broker should always act in your best interest and therefore should you decide to accept the risks of offering a loan guarantee you ask the mortgage broker to have the bank (or other lender) ensure any guarantee is limited.
There are certainly a lot of issues to think about, but it shouldn’t stop you from offering to help if you really want to – just make sure that you understand the risks of going as a guarantor and explore the other options that you have.
Contact us to discuss the risks of going guarantor.