What does it mean to be a guarantor under a loan?

Who is a Guarantor?

A guarantor is a person who is liable to perform the obligations of the borrower, if the borrower fails in their performance of the obligations. Typically, it is a direct family member such as a parent or a sibling and the asset would generally be a house.  

A ‘guarantor’ legally agrees to repay the amount if the debtor refuses or is unable to repay the loan. It entails more than simply supporting a friend or relative who requires financial assistance because the guarantor will be held liable if the debtor defaults any payments.

Guarantees from all Company Directors, as well as shareholders in certain circumstances, are necessary when a Company borrower is involved in an application.

It is a term that you often hear when you’re obtaining a loan to purchase a house or for any other purpose. It is of paramount importance that you obtain independent legal and financial advice before signing as a guarantor.

What is a guarantee?

Guarantees are legally enforceable agreements between three parties:

1. The credit provider (lender).
2. The debtor (borrower); and
3. The guarantor

Each bank will have its own requirements for guarantors, but you can anticipate them to need a strong credit score, sufficient equity to use as security, and a reliable income.

What can the guarantor offer as security?

Typically the lender will only accept individuals who have assets to be guarantors.

Assets can be;

1. Cash such as tucked away savings or term deposit funds
2. Equity from your home

 

What is Equity?

An asset’s equity is the difference between its value and any money owed on it. For example, if your house is worth $600,000 and your current mortgage is $200,000, your home’s equity is $400,000.

You need not provide any money up front, there will be no exchange of money, or you are not required to put money out of pocket when the agreement is made.

In what circumstance will a guarantor be required?

When your young adult children, spouse, sibling or business associate does not have their own finances or equity in a property that they own as security for the loan amount, the lender will require them to provide security in obtaining the loan.

Obligations

• In the event that the borrower fails to meet their obligations under the loan, the lender will enforce the borrowers obligations through you; the guarantor. You will then need to step in and pay the outstanding loan amount.

• Typically, if the borrower is a corporate entity, its director will be required to provide a personal guarantee to the lender. Where the company is unable to repay its debts, the lender will seek to enforce the companies obligations through the directors personal guarantee.

Benefits to the principal

Having a guarantor for loans have numerous advantages and opportunities, depending on the borrowers’ financial objectives.

1. With the availability of a guarantor, the lender will be more willing to provide finances to a borrower without significant credit history.
2. If the borrower is buying a home or a vehicle, having a guarantor allows them to obtain the loan faster and facilitate them with the purchase.
3. The borrower does not have to pay Lenders Mortgage Insurance.
4. The bank may provide a better interest rate as having a guarantor lowers the risk and ambiguity as to the repayments.

The risk of being a guarantor

The only primary risk involved with being a guarantor for a loan is that if the loan repayment is not made for any reason, then the lender may not only take the applicants’ property. But they can seize the assets that was provided as security for the loan.

Therefore, as the guarantor you need to make sure that you’re satisfied with the applicant’s financial circumstances as well as your own ability to handle any default.

Importance of obtaining legal advice

You need legal advice in order to determine your liabilities and responsibilities in the event that the borrower defaults. By seeking independent legal and financial advice you would fully understand your obligations, risks, and impact on your financial status. It’s crucial to be aware of your obligations and sign any guarantor documents free of outside influence or pressure.