Going guarantor on a loan

These days, breaking into the property market is a difficult task.

Which is why many Australians, particularly those who are parents, may find themselves in the position of being asked to go guarantor on a loan.

Going guarantor is a great way to help a friend or family member become a property owner sooner, but before you jump in and agree to going guarantor, you need to know what you are getting yourself into.

Agreeing to go guarantor is the same level of commitment as being the borrower yourself, because if the borrower is unable to meet the repayments, you will be responsible for them.

Yes, this means you will be up for repaying the debt or allowing the sale of the property you have offered as additional security, to repay the part of the debt you guaranteed.

But is there a way to go guarantor without risking yourself entirely?

And how likely is it that the borrower you are helping out will ever default on the loan anyway?

Either way, it’s best to be prepared for every possible circumstance.

We discuss the top five things you should be aware of before you agree to go guarantor.

The amount of money a guarantor could be up for if the borrower defaults on their loan depends on the guarantee they have signed.

The money you would owe in the event of a default may be expressed as a dollar limit plus interest, expenses and recovery costs.

The exact figure here will depend on the amount owing under the specified loan, the value of the property borrowed against and any other assets used as security at the time of loan recovery.

Depending on the lending institution, there is also a chance that the borrower can increase the amount of funds under mortgage at a later date, and the guarantor needs to ensure that the guarantee states that any such changes will be at the discretion of the guarantor.

In some cases, guarantors also cover business loans and will be asked to give an indemnity for any loss the lender suffers in connection with the guarantee.

No matter what type of loan you are going guarantor for, you need to make sure you have had the guarantee thoroughly examined to determine what you will be required to pay in the event of loan default by the borrower.

Are you even in a position to go guarantor?

Even if you’ve determined you will have the means to avoid financial ruin if the borrower defaults on the loan you’re guaranteeing, there are other requirements a guarantor must meet.

Firstly, you must have sufficient equity in the property you are offering as security.

Secondly, you will need to meet the red tape requirements of:

• Confirming your identity
• Providing any personal information required by the lending institution
• Opening your own financial situation up for scrutiny.

If you are averse to paperwork, be aware that it will start to mount just to get the guarantor process off the ground!

Even if you feel you satisfy all of the basic requirements for going guarantor on a loan, you must also ask yourself these important questions:

• Have you talked to your financial adviser about your plans to go guarantor?

This is a critical step before entering into any situation where you will be financially liable for a loan, particularly one that may require the security of your principal place of residence.

At First Financial, our team of specialists can assist you to make the right choice when it comes to managing your wealth.

Ask your financial adviser for financial modelling to foresee any associated issues that going guarantor might open you up to before you push the go button.

• Will the borrower be able to repay the loan on their own?

You might also need to run these figures with your financial adviser, and ensuring you are privy to all of your borrower’s financial information is imperative to understand the level of risk you are opening yourself up to by going guarantor.

Can the borrower even afford to have the loan in the first place as far as repayments go?

Answering this question is key to assessing your risk as a guarantor.

This may seem like a bit of a ‘so what?’ question, but when you are considering going guarantor on a loan, it’s actually really important to assess your relationship with the borrower, and the lender will think this too!

Many lenders will not accept guarantors on loans from non-family members, particularly in an environment where interest rates are on the rise and lenders are tightening their loan approval processes.

The most common situation for a loan guarantor is being ‘the bank of Mum and Dad’, a scenario where grown-up children require assistance from their parents to buy a property.

Over the past few decades, there has been an increase in parents becoming guarantors on home loans for their children, and most lenders will expect a guarantor to be a parent, step-parent, grandparent or sibling.

If you are down to the nitty gritty of becoming a guarantor, there are different types of guarantees you may be faced with and, once again, we suggest discussing with your financial adviser which one best suits your circumstances before you sign on any dotted lines.

Your financial adviser can also assist you to determine other types of specialist advice you may need at this point, such as solicitor assistance.

The types of guarantees include:

• Security guarantee

A security guarantee is the most common type of guarantee and means the guarantor secures the loan for the borrower against their own property holding.

• Limited guarantee

A limited guarantee is when the borrower and the guarantor determine a limit for how much the guarantor is liable for in the event of default.

This is where you get to decide where you opt out of the guarantor situation if the buyer defaults, and in this type of guarantee, the guarantor will not be responsible for the entire loan.

• Security and income guarantee

This is where the guarantor needs to provide a property security and proof of income. Most lenders prefer this option for first home buyers with low income, and in some situations, the guarantor will actually help to make repayments for the borrower until they can afford to take over.

Becoming a guarantor is a huge responsibility and it’s okay to say no.

Being a guarantor may not suit your financial situation or you may not wish to open yourself up to loan liability, depending on your circumstances.

But if you do want to assist a borrower, there are other ways you can help.

Instead of guaranteeing the loan, you could help the borrower to save their deposit by providing a cash payment or assisting them with cheaper living arrangements while they save.

You could look at making extensions to your own property to house the borrower and get them out of the rental cycle.

Or you could consider other types of financial assistance that might better suit your personal situation.

A thorough analysis of your financial situation is necessary to determine whether or not you have the capacity to become a guarantor on a loan.

If you are considering taking this step, seek the assistance of your financial adviser first, to walk through all of the steps you would need to take to make this happen, and the risks and obligations you will be faced with.

At First Financial, we offer holistic financial advice that walks you through the milestones in your life that impact your financial wellbeing.

For more information, contact us today to discuss your specific financial situation.