The risks of going guarantor

Has a family member asked you to provide a guarantee for their home loan or personal loan? If so, you need to be clear about your obligations under a contract of guarantee.

What is a guarantee?

If a lender is concerned about a borrower's capacity to repay a loan or has classified the borrower as a high credit risk, the lender may ask a third party to provide a guarantee that he or she will pay back the full amount of the outstanding loan if the borrower defaults.

If you sign a guarantee for a friend or family you become a "guarantor" of the loan. In other words, you will become responsible for the borrower's debt if they do not repay the loan.

There are guarantees for fixed amount or "all monies". All monies guarantees are for all amounts owing under the loan, now and in the future (including such things as the principal, interest, fees, costs and expenses).

The risks of providing a guarantee

You are obliged to inform a credit provider of any loans on which you have agreed to act as guarantor. A credit provider will take into account your obligations under the guarantee when considering your capacity to repay a new loan. Even if the borrower is meeting his or her repayment obligations, your guarantee could affect your ability to secure new financing.

If the borrower does not pay back the loan, you could end up with a bad credit record, which will make it harder for you to borrow money in the future. Further, if you provide your house as security, you could risk losing your home if you are unable to meet the obligations of the loan guarantee. A lender can also take steps to make you bankrupt if you are unable to pay back the loan, in order to access your assets to satisfy their debt.

Questions to ask before agreeing to provide a guarantee

As can be seen, there are many financial risks associated with acting as a guarantee with very little reward. Before providing a guarantee, we recommend that you consider the following questions:

• how does the borrower intend to repay the loan?
• can you repay the loan amount if the borrower does not meet his or her repayments?
• do you have to put up assets as security?

Independent legal advice

A lender will generally ask for evidence that a guarantor has obtained independent legal advice on the potential consequences of entering into the guarantee before signing the guarantee contract. That is because guarantees can be unenforceable if one party is found to have been induced into entering the transaction by another party's undue influence. There are certain circumstances where undue influence is presumed (for example, husband and wife relationships and where the transaction seems to clearly benefit one party and not the other).

Insisting that a guarantor obtain independent legal advice provides protection to a lender that a guarantee will be enforceable.

Conclusion

A guarantee is a contract with significant legal and financial consequences. You should think carefully before agreeing to provide a guarantee and obtain independent legal advice before signing any documents.

If you or someone you know want more information or need help or advice, please contact us on (02) 9274 8820 or email [email protected].