Are you guaranteeing a loan?
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23 May, 2013 | Wade Hansen
It has become standard practice for banks to require guarantees from family members when the borrower does not have at least 20% equity in the property they are looking to purchase. One of the most common situations is when parents are asked to guarantee the lending of their children so that they can buy their first home.
We know that parents always want to think the best of their children and that they know their children are responsible and reliable. However, guarantees are generally only called upon in worst case scenarios.
After the 2009 and 2010 earthquakes in Christchurch, people were forced to move out of their homes and pay rent for temporary accommodation on top of having to continue to meet their mortgage repayments. This led to a lot of borrowers defaulting on those payments. Natural disasters aren’t the only risk. A borrower could be made redundant and unable to find another job immediately or they could become seriously ill which means they cannot work for an extended period of time again leading to defaulting on payments.
These are all examples that are not too far from the reality everyday New Zealanders are living in. Add to this the fact that the borrowers who need guarantors are borrowing between 80-100% to purchase the property which puts increased financial pressure on these families from the outset.
Due to the risks involved, a guarantor always needs to obtain independent legal advice (i.e. you need to see a lawyer from a different firm than the firm the borrowers are using for their purchase). In fact, the bank demands it.
While this can be frustrating for clients, it is however necessary. The lawyer who gives you the independent advice must be able to certify that they have met with you as the guarantor and have advised you when you were not in the presence of the borrower. They must also certify that they (the lawyer) are completely independent of the borrower (i.e. have never acted for the borrower before).
When meeting with a lawyer in relation to providing a guarantee for someone else’s loan, the lawyer should always cover four main points in their advice:
There are two types of guarantee – unlimited or limited to a specified amount or specific loan.
If the guarantee is unlimited you are securing all money that is owing to the bank by the borrower including principal and interest and all money that the borrower is guaranteeing for other parties, both what is outstanding at the time you sign the guarantee and all future indebtedness. This means if the borrower takes out further lending with that bank at a later date (including against an entirely different property), your guarantee will cover the new lending. The bank may not even be required to notify you that the borrowers have taken more lending.
A limited guarantee is just that. You can limit the amount that you will be liable for as guarantor to a certain amount or to a specific loan. This way, if the borrowers take out more lending, you may not be liable for all of it. Please talk to a lawyer about these options.
If the borrower defaults on any repayment, you will be liable to meet those repayments. If you are unable to make the loan repayments then the bank is entitled to take further action including potentially forcing the sale of your house or any personal assets that you hold. You could lose your home and/or you could be made bankrupt if you do not have sufficient assets to cover the borrower’s obligations.
Basically as guarantor you are as responsible as the borrower themselves for paying back the loan.
You should be made aware of:
You always have a choice.
If the Bank won’t lend to your children if you don’t provide the guarantee it is because they are high risk in terms of their loan to security ratio. There is simply not enough equity in the property for the bank to be comfortable that they could sell the property at mortgagee sale and recover all of the amounts owing to them plus any interest and costs.
The decision should be yours alone. If your guarantee does get called upon, you cannot claim a defence of duress due to the fact that you only signed it to get your children into a property. You can say no and insist that the borrower wait until such time as they have sufficient equity to purchase without the need for a guarantee.
The final question you should be asked is despite all of the advice you have received regarding the risks and consequences involved, thinking about the potential worst case scenario – do you still want to go ahead and guarantee the borrower?
If you are not happy you can ask your lawyer to go back to the bank and ask them to limit your liability in some way. The bank may not agree, however, it is worth asking. For example, the bank may be happy limiting your guarantee to 20% of the house value – this always seems to be the banks’ magic number.
Hopefully, this article has identified a few issues to think about as a guarantor. Next time you are asked to provide a guarantee, have a long hard think about risks and the consequences of if or when you are called upon to meet the obligations of the borrower.
Trusting a person to keep meeting their obligations doesn’t mean that they are shielded from the vagaries of life. Worst case scenarios can and do happen. In any case, contact an independent lawyer and have an in-depth discussion with them before signing any guarantee.
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22 February, 2012 | Wade Hansen
7 March, 2012 | Wade Hansen