Have you ever been asked to guarantee someone’s loan? The most common scenario is children asking their parents to guarantee their loan to buy a car or a home. If this question is ever asked of you, give long and careful consideration to before committing to an answer.
What is a Guarantor?
In the context of this discussion, a guarantor is generally used where a credit provider or lending institution (‘the Lender’) isn’t willing to give a loan to an applicant on their own. This will generally be where the person applying for the loan (‘the Borrower’) doesn’t have a sufficient deposit or sufficient security to secure the risk of the debt.
When this happens, the Lender will require the Borrower to find a Guarantor. The Guarantor is the person who promises the Lender they will pay the Borrower’s debt if the Lender requires them to.
When will the Guarantor have to pay?
Having a Guarantor in place on a loan gives the Lender extra security in the event the Borrower can’t or won’t repay the loan.
The wording of the guarantee documentation is really important here as it sets out when the Guarantor will be required to make payment and how much the Guarantor will be required to pay. Often Lenders will give the impression that the Lender will only seek payment from the Guarantor as an absolute last resort. This is generally untrue.
Most guarantee documents state that the Lender can claim payment from the Borrower or the Guarantor at any time. There is usually no obligation for the Lender to exhaust all payment possibilities with the Borrower first. That means it is entirely up to the Lender who they seek payment from – and they’ll often proceed against the party who can satisfy the debt in the quickest and easiest manner for the Lender. It is important to remember that a guarantee is only put in place for the Lender’s security and convenience.
Under most loan agreements with banks, the bank can deduct any debt owing by the Borrower from the Guarantor’s savings with that bank. The Guarantor does not have to authorise the deduction from the account at the time of withdrawal, because the Guarantor has already given authorisation in the initial guarantee documents.
There are all sorts of unexpected ways that the guarantee could be called upon. It is very easy for even the most sensible and reliable of Borrowers to fall into financial difficulties and be unable to service the debt. For example, a Borrower could unexpectedly lose their job, become seriously ill or incapacitated and no longer be able to work, or they could experience a relationship breakdown which affects their ability to service their loan. If there’s a relationship break-down, a Guarantor could end up guaranteeing a loan on a home that is being lived in by the ex-partner of the Guarantor’s adult child, whilst the child and the ex-partner go through Family Court proceedings.
A guarantee is generally a long-term agreement, usually lasting for the duration of the loan. The Guarantor could be called upon to make payment many years after entering into the guarantee documents.
A Guarantor should think about what he/she could lose if required to pay the Borrower’s debt. If the Guarantor can’t pay the debt when called upon to do so, the Guarantor could be given a bad credit rating or be drawn into Court proceedings in relation to the debt.
Acting as guarantor on a loan may also affect the Guarantor’s ability to borrow funds themselves, as credit providers will generally take this guaranteed debt into account when processing the Guarantor’s loan application.
What will the Guarantor have to pay?
The actual guarantee agreement is very important. Independent legal advice should be obtained by the Guarantor before entering into any agreement – which is something that most Lenders require.
Whilst some guarantees are limited so that the Guarantor is only liable to cover up to an agreed amount, this is not common. Generally, most guarantees are open-ended, and the Guarantor is guaranteeing everything the Borrower owes in relation to the loan – not just the initial amount borrowed. This could include charges, fees and interest which has accrued on the debt.
The Guarantor should be very clear on which type of guarantee they are entering into before signing and should never take the word of the Lender or the Borrower, as these parties have a vested interest in getting the Guarantor to sign.
Does the Guarantor have any interest in the property purchased with the loan?
No. The Guarantor guarantees the debt but has no ownership or rights in relation to the property or item purchased with the monies borrowed. This could leave the Guarantor in the position that they have had to pay out their child’s car loan, but their child retains full ownership of the car itself.
Can I end the guarantee if I change my mind later on?
A Guarantor generally can’t withdraw agreement to guarantee a debt without the Lender’s agreement. The Lender generally won’t agree to the guarantee ending unless they are assured the loan will be secured elsewhere.
If the Lender doesn’t agree to ending the guarantee, the guarantee continues, and the Guarantor has no power to end the agreement due to change of mind or falling out with the Borrower.
Should I guarantee a loan?
Guarantees can be very easy to get into but very costly and difficult (or impossible) to get out of. Agreeing to be a guarantor can have serious financial consequences – and not straight away. Guarantees can extend for many, many years and be something the Guarantor completely forgets about until the Lender expects the Guarantor to pay up.
Extremely careful consideration should be given before entering into a guarantee, especially when family pressure is being exerted by children or other loved ones. My general advice in relation to giving a guarantee – when in doubt, just don’t.