Since the global financial crisis, financial institutions and credit lenders have increasingly required a third party to guarantee a borrower’s loan. This means a third party (the Guarantor) enters into a contract of guarantee with the financial institution to answer for the debt of the borrower in the event that the borrower defaults on repayment or any other terms of the loan/credit.
Becoming a guarantor is not something to be done lightly with serious ramifications if the borrower defaults.
Standard contracts of guarantee often provide that the Guarantor will make full repayment of the outstanding loan, plus any interest and any costs of the lender in pursuing the default of the borrower. If this is taken into account, it could add tens of thousands of dollars to the loan amount being guaranteed.
Often, Guarantors guarantee believing that they will never be called on to answer for the debts of the borrower; particularly when guaranteeing the purchase of a child’s family home. The Guarantor believes that repayments will be made etc. as the borrower(s) are employed and have a good financial history.
Instead, Guarantors should be asking themselves the question(s) – if I had to make payment of the Loan tomorrow or next week how would this affect my financial position, my quality of life, my future retirement plans? Circumstances can quickly change and numerous events can cause a borrower to default including:
· a borrower being in an accident and being permanently disabled and unable to work;
· the borrowers might divorce; or
· one or more of the borrowers might become a party to litigation.
Throughout the term of the loan (and the Guarantor providing the guarantee) it is prudent for the Guarantor to:
· request financial statements from the lender to confirm that the borrower is making its repayments; and
· have insurance over the borrowers for trauma, total and permanent disability and life for the value of the loan.
It is very important that Guarantors get legal advice on the terms of the contracts of guarantee (and the loan being guaranteed) so that they understand:
· what they are signing;
· what obligations of the borrower they are guaranteeing;
· what financial and legal ramifications there could be;
· when they will be released from their obligations as Guarantor.