Thinking about Guaranteeing a Loan? Make sure you're aware of the risks
Let's face it - we love our children and we want to help them in any way we can. With house prices soaring all over the country, it's understandable that most young adults today have a difficult time saving up for a deposit to buy their first home or upgrade in preparation to start their own family.
If you are thinking about becoming a Guarantor for your child's home loan, or maybe even a business loan for a close friend, it is very important that you understand the risks involved. These days, before you can become a Guarantor for a loan, you should obtain independent legal advice from a lawyer to confirm that you have been made aware of the risks involved.
Now you may think that the risks are obvious and legal advice on the subject is just another box to be ticked to enable you to proceed. We believe this step is extremely important for the following reasons.
You may be forced to sell your home.
Being a guarantor on a loan means that you guarantee to repay the loan (or the portion of the loan that you have guaranteed) if the borrower fails to repay the debt. This could mean that you may be forced to sell your own home to repay the debt if you are unable to come up with the cash when the debt falls due.
If you are guaranteeing a loan by using the equity in your own home, it is important to consider this significant risk and put a plan in place in case the borrower is unable to repay the debt for whatever reason. This may mean having a plan in place as to what you would do if you did have to sell your home. Where would you live? Could you afford to purchase another home?
If the borrower is unable to repay the loan, and you are unable to repay the loan, the default will affect your credit rating. An insurance policy is an important option to consider if the borrower becomes ill or injured and is unable to repay the loan. Consider making an income protection policy part of the agreement to guarantor a loan.
If the borrower is unable to repay the loan, not only do you become liable for the amount that you have guaranteed, but you will also be liable for any default costs, interest and recovery costs that may apply in the lender's attempt to recover the debt. This sum can be much greater than the amount originally guaranteed. Often the lender does not need to pursue the borrower before coming after the guarantor.
You may not be able to borrow money / your borrowing power will be reduced.
If you use the equity in your home to secure your guarantee for a loan, you will not be able to use that equity again until the guarantee has ended should you wish to rely on that equity for borrowing power.
The guarantee that you provide using the equity in your home does not give you any rights to any property being bought with the loan, nor does the guarantee improve your credit rating.
If in the future you might wish to use the equity in your home to buy another home, start a business, draw funds to go on a holiday or even purchase a new car, you need to think carefully about whether you want the equity to be tied into a guarantee which is likely to be in place for a number of years.
It is important to consider obtaining financial advice (as well as legal advice) if you fall in this category before you commit to guaranteeing a loan.
Your relationship with the borrower may change.
We never anticipate that things could go terribly wrong when you entrust a child, family member or close friend to do the right thing by you, but sometimes it does. There is never any guarantee that the relationship you have with the borrower will continue the way it always has after your guarantee has been made on the loan.
In every circumstance, even if you are guaranteeing a loan for your own child, you must consider what would occur if the relationship were to change or break down for whatever reason, and there are difficulties communicating with the borrower about your guarantee on the loan.
A guarantee for a loan often cannot and certainly cannot easily be revoked. Even if there is a relationship breakdown between you and the borrower, you will, most likely, be left in the hands of the lender should you wish to attempt to revoke the guarantee and may need to communicate with the borrower to see whether arrangements can be made to revoke the guarantee.
Remember - it's OK to say no. You might think that this is an impossible decision to make but it may end up saving your relationship with the borrower in the longer term.
It is an important step in the process of becoming a guarantor for a loan to sit with a lawyer and discuss the above and other options that may be available to you (instead of a guarantee). It is important to make sure that you understand the risks and you have a "back up plan" in place if something goes wrong.
A lawyer must sign a certificate of advice to confirm that you have received legal advice about the risks involved. A lawyer will also check in with you and ask questions to make sure you truly understand what you are signing up for and make sure that you are not feeling pressured or threatened to sign a guarantee.
For more information about guaranteeing a loan, visit the Legal Aid NSW website on "helping your family financially" or the Moneysmart website on "love and loans".
Ardent Lawyers are happy to meet with you and discuss your options if you are considering becoming a guarantor for a loan. We can also sign your certificate of advice once we have met with you and gone through with you in further detail the risks that apply to your individual circumstances.
If you have any questions about guaranteeing a loan, contact Ardent Lawyers on (02) 4444 6808 or contact@ardentlawyers.com.au.