Being a guarantor will negatively impact on your own finances. Before agreeing to become a guarantor for a loan, it is vitally important to understand what you are committing yourself to. Essential knowledge includes:
- what a guarantee is;
- what to look for in the terms and conditions; and
- how to protect yourself.
What is a guarantee?
A loan guarantee is a written legally binding contract between a lender and a guarantor. The guarantor is promising to repay a debt obligation of a borrower, if the borrower defaults. The debt obligation could include outstanding prior debts, principal, interest and default interest, as well as any costs incurred by the bank in calling in the debt.
What do you need to look for in the guarantee?
Check the terms and conditions, in particular;
- Limited or unlimited- A limited guarantee is usually limited to a specific agreed amount, not a guarantee of a particular loan. It is a guarantee of all the borrower’s indebtedness to the lender. However many lenders will not limit a guarantee and could call on a guarantor to cover any debt including credit cards and any future borrowing. If you only want to guarantee a particular loan you will need to negotiate with the lender.
- Continuing guarantee- Most guarantees are continuing guarantees. This means if money borrowed subject to the guarantee is repaid and more money is borrowed the guarantee will continue to apply. If guaranteeing a specific debt you should get the guarantee released once when the debt is paid back.
- Security- A lender can ask the guarantor to use his or her own home as security for the borrower’s loan by asking for a mortgage to be registered against the title. If a mortgage is registered the lender could sell the guarantors home to recoup the loans and associated costs if a borrower defaults.
- Joint and several- Liability under a guarantee can be joint and several, meaning if there is more than one guarantor, they would both be liable for the entire debt. A lender can choose to proceed against one guarantor and their assets rather than the other or in fact the borrower, if the lender believes that guarantor has the means to pay.
- Termination- A guarantor may terminate a guarantee at any time. However the guarantor will still be liable for debts incurred before the termination. By terminating a guarantor will not be liable for debts incurred after written notice of termination has been given to the lender.
- Release- To be released from a guarantee most lenders require either the debts to be repaid or replacement security to be given. A release is not automatic on repayment of the debt or replacement of security . The guarantor will need to request and obtain a release to ensure they are not responsible for future borrowings.
You must familiarise yourself with the borrowers financial situation, including why the guarantee is required. Look at what obligations the borrower has and what obligations they are intending to take on. Do you think the borrower is likely to let you know if they start to have difficulty meeting their obligations. Check the borrower’s credit history and whether they have the means to meet their commitments.
Ask the borrower to arrange mortgage protection insurance especially in relation to illness and possible job loss.
Always get independent legal advice. Ask your own lawyer or at least a different lawyer from the borrower, to look over the guarantee with your interests in mind. Like any contract, the lender may be open to negotiation, allowing you to limit your exposure while enabling the borrower to borrow.
Never guarantee more than you can afford. Determine what the repayments are if the borrower defaults. How does this fit with your own finances? Going guarantor for some else will restrict your ability to borrow. Your lender will factor in the guaranteed amount when considering your own loan application, even if the borrower has not defaulted.
Armed with the knowledge as to why the guarantee is required and what the associated responsibilities and obligations under the guarantee are, you will be able to decide whether you are in a position to help meet a borrower’s obligations if the borrower defaults.
Above all, always exercise caution and seek independent legal advice before signing anything. Your lawyer will be able to look at your particular circumstances and may be able to advise you on other options you may not have considered.