If a lender suspects a borrower may not be able to repay a loan, they may request that a third-party (guarantor) guarantee repayment of the loan and/or performance of the obligations of the borrower.
So what do you need to know before becoming a guarantor?
What is a guarantor?
A guarantor is someone who agrees to be responsible for:
- repaying a debt owed to the lender under a loan provided to another individual or business; and
- complying with the obligations of the borrower(s) where they cannot make their repayments or comply with their obligations.
When do lenders ask for a guarantee?
Ordinarily, a lender will require third-parties guarantee a loan depending on whether the borrower is a personal borrower or non-personal borrower.
Where the borrower is an individual, the lender may require a guarantee from:
- the wife or husband (including a de-facto partner);
- a family member of the borrower;
- co-owner of any property or asset acquired using the borrowed funds.
Where the borrower is a company or trust, the lender may require a guarantee from:
- all company directors as well as shareholders (where applicable);
- trustees/appointors of the trust.
What are the risks of acting as guarantor?
Before agreeing to act as guarantor under a loan, you should be:
- familiar with the borrower; and
- confident that you can meet loan repayments and obligations if they cannot.
As guarantors are responsible for repaying the loan and complying with the obligations of the borrower under the loan agreement, guarantors should always take the same care as if they were taking out the loan for themselves.
If you act as a guarantor:
- you may have to pay the entire loan;
- it could prevent you from getting a loan;
- you could get a bad credit report; and
- it could damage your relationship with the borrower.
What are the benefits of acting as guarantor?
There are no benefits to you if you agree to act as a guarantor, the only benefit is to the borrower being able to obtain the loan by virtue of providing the lender with added security by involving a third-party guarantor to the loan.
Are guarantees usually secured or unsecured?
If you have been asked to act as guarantor, the loan documentation will set out whether your guarantee is to be secured or unsecured.
If it is unsecured, the lender does not require an additional form of security from the guarantor (i.e. a mortgage over the guarantor’s property) to secure the guarantee.
In the alternative, a secured guarantee means that the lender requires that the guarantor grant an additional form of security (i.e. a mortgage over some of the guarantor’s property) to secure the guarantee.
From a borrower’s perspective, you will always want the guarantee to be unsecured for obvious reasons, however this might not always be possible in circumstances where your income is not sufficient to cover the loaned amount in the event that the borrower defaults.
Can a guarantee be limited?
A lender can propose a guarantee for fixed amounts or all monies. As a guarantor, you will always want to ensure that the guarantee is for a fixed amount and states the exact amount of money will owe if the borrower defaults.
If the guarantee is for all monies, you should request that the guarantee be limited to a fixed amount before you agree to act as guarantor.
What documents should a guarantor review before agreeing to act as guarantor?
If you are a guarantor, you should receive the following from the lender:
- a copy of the loan agreement in final form; and
- a clear and concise document that explains your rights and duties as a guarantor.
When you receive these documents you will find a notice that requires you to seek independent legal and financial advice about the guarantee and how it may affect you if the borrower defaults.
Before you sign a guarantee agreement, you should have a solicitor:
- conduct a comprehensive review of the terms and conditions of the loan agreement and guarantee agreement so that you understand your rights and obligations; and
- sign the guarantee agreement to confirm you have obtained independent legal and finance advice about the guarantee.
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