Has somebody you know asked you to be their guarantor? Are they struggling to save a deposit, or can’t seem to get a loan? In simple terms, a guarantor can help another person secure a loan, such as a home loan from a bank, by ‘guaranteeing’ it, using their own property or income as security.
In this context, ‘security’ refers to an asset you own, such as a property or vehicle, which you offer up to convince a bank or other lender to loan money to someone. If the loan is not paid off, the lender can then sell the asset in order to recoup the money it has lost.
This arrangement is becoming more common in recent times, where due to the state of the Australian property market, many parents are choosing to go guarantor to help their adult kids clear the high bar to entry on home ownership. If you are in a position to offer this kind of help, it has the potential to assist your child in a meaningful way, and make breaking into the market much easier for them.
You could also be required to go guarantor if you are the director of a company, and that company is borrowing in its own capacity. That said, the remainder of this post will deal primarily with ‘personal’ guarantors, as described above.
The decision to guarantee another person’s loan is not without risk. It is very important that you fully inform yourself of the possible consequences before making the decision to go guarantor for someone, even your family.
When going guarantor, you will generally also need a solicitor’s certificate. See our other blog post on the topic of solicitor’s certificates for more information.
Advantages
In the context of home loans, the benefits to be enjoyed by the borrower can be significant:
- For many borrowers, having a guarantor means they are able to pay a reduced deposit when purchasing their new property. This has the flow-on benefit of allowing borrowers into the market sooner, rather than having to wait (sometimes years) to save a larger deposit for their loan.
- Where a smaller deposit is being used, having a guarantor can also allow a borrower to avoid paying lenders mortgage insurance on their loan, which can help reduce financial strain associated with their purchase.
- Some lenders offer a lower interest rate if a guarantor is supplied.
Disadvantages
The primary disadvantage for guarantors in this arrangement is that it reduces their own borrowing ability.
- When you go guarantor for someone else, just like any other debt, the amount lent to the borrower is listed against your name, too. If you have your own plans to obtain a loan down the track, the lender you engage with will take this into account.
- This is true even where the loan is being paid down, and depending on how long it takes the borrower to pay it out, it can continue to affect you for years, or even decades (many home loan terms are for 30 years). Accordingly, it is highly important to consider your own long-term goals before offering to help someone else.
- Do you have multiple children? If you are part of the roughly 80% of Australian households who do not own any other real property besides your home, making the decision to go guarantor for one child may leave you unable to assist any others you might have. This is because you are unlikely to be able to offer any other form of security if your home is already securing another loan.
- On a similar note, whilst your property is being used as security, this will often leave you unable to sell or transfer that property until the loan is paid out. Sometimes, lenders may be willing to negotiate around this issue, but if you have plans to sell this should be investigated before agreeing to anything.
Risks
Unfortunately, going guarantor exposes you to significant potential risk. There are ways to minimize the risk, but it is also important to be aware of what could happen:
- The borrower may default. If the person you are going guarantor for becomes unable to meet their obligations, the lender can instead pursue you for the unpaid debt, interest, and their legal costs. This is particularly problematic if you used a property to secure the loan for the borrower, which may now need to be sold to satisfy the debt. Often, this security is the guarantor’s home.
- Some loan agreements also contain terms which, in the case of default, allow the lender to skip over the borrower and go straight to you to satisfy the debt. Always read the fine print!
- If the borrower can’t pay back the guaranteed loan, their default will also be listed against your name because you acted as guarantor. This information will appear in future credit reports and will make it harder for you to obtain a loan for yourself later on.
Alternatives
To avoid the risks of going guarantor, you might consider other ways of assisting somebody who is trying to buy a property:
- You could make a gift of cash or give an early inheritance. If the person you want to help is having difficulty saving the required deposit to purchase their property, you may decide you want to assist them by paying part, or all of the required amount yourself. Obviously, not everybody will be in a position to do this, but it can be a safer alternative if you are concerned about losing your security, or impacting your credit score: Simply providing the money limits your liability, so you are not officially involved in the transaction, and cannot be pursued personally if the borrower defaults on their loan. However, that said this option is not without its own risks, and we strongly encourage you to discuss your plans with us before making any gifts.
- You could ‘be the bank’ yourselves. You could lend the borrower the required funds to buy the property and lodge a mortgage against it meaning you would hold the title until they pay the loan out.
- You could purchase the property yourself, either outright or with a mortgagee, taking out the home loan in your own name instead of your child. If you are in the exceptional financial position to pursue this option, it is a very generous gesture, and removes the risk for your children altogether, instead having it rest with you. From here, you can make any arrangement you like with your child, such as leasing the property to them. Do chat with us about this option as well, because it can be costly to transfer to your child in the future, should you wish to do so.
Going guarantor has a great potential to help people realise their dreams of owning property, and is especially relevant in the contemporary Australian property market However, the decision to engage with this process needs to be carefully considered against the potential for something to go wrong.
Whatever your inclination, the friendly and experienced team at Wakefield Vogrig & Boote are ready to advise and support you through the process. If you would like to speak to someone or get advice about going guarantor, please get in touch with us at our Warragul or Drouin offices today.
Authors:
Martin Bridson – Lawyer
Disclaimer: The information in this post is general in nature. This does not constitute legal advice and should not be relied on as such. Please contact one of our Lawyers if you are seeking advice about a specific legal matter.
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