Record house prices are forcing first home buyers to seek financial help from their parents. One form of financial help is for parents to act as guarantors on their child’s mortgage.
What is a guarantee?
A guarantee is where a person agrees to be responsible for the debt of another person. A good example of this is where the Bank of Mum and Dad guarantees the value of a mortgage to the bank to help their child purchase a home.
What liability does a guarantor have under a guarantee?
While you may be able to specify a guarantee limit, generally the liability of a guarantor is unlimited. If the guarantee is unlimited, the guarantor will be liable for everything the borrower borrows from the bank. This includes all money owing or that becomes owing by the borrower, whether at the time the guarantee is signed, or in the future.
The bank may claim interest owed and any costs incurred in recovering the guaranteed amounts.
Importantly, the bank is not required to take action against the borrower before making demand of the guarantor.
The liability of the guarantor is secured by any security that the bank may from time to time hold over any property of the guarantor. Where the guarantor is an individual (i.e. the parents), this may include a mortgage over the guarantor’s family home.
Does a guarantor need independent legal advice?
In most cases, parents acting as guarantors will be required to take independent legal advice so they know exactly what they are getting into.
If a guarantor has a relationship involving an emotional tie with or dependency on the borrower or has limited commercial ability or does not derive any more than a minimal direct or indirect financial benefit or advantage from giving the guarantee, the guarantor must receive independent legal advice, in the absence of the borrower, before signing the guarantee.
Can you terminate a guarantee and what are the consequences of termination?
Most guarantee documents provide guarantors with a limited right to terminate the guarantee in relation to the future indebtedness of the borrowers. It may be possible for the guarantee to be released as soon as the value of the child's property rises sufficiently to give them enough equity to cover it.
In order to terminate liability, the guarantors must give notice in writing to the bank.
The guarantor remains liable for all existing indebtedness up until the date that notice of termination is given.
It is likely that the guarantor's termination would result in the bank either capping the amount that can be borrowed or calling up the moneys then owed by the borrower.
Although the giving of a guarantee may be a condition of the bank lending to a borrower, there is no legal obligation on the guarantor to provide the guarantee. Doing so however may result in finance being declined or limited. If you do not wish to incur any liability in relation to the indebtedness of a borrower, do not sign a guarantee.
Before agreeing to provide a guarantee, ensure you get in contact with us first for advice.