At Johnston Withers Lawyers and Conveyancers we love helping South Australians achieve the great Australian dream that is home ownership. Seeing the joy on our client’s faces when they settle on the property is what drives us to be the best in our field.
For many people saving the deposit seems out of reach. It has become quite common for our parents, aunties or siblings to provide a personal guarantee to help their loved one get into their own home or invest in real property by minimising the deposit a person needs to save.
A guaranteed loan is a loan that a third party guarantees (and assumes the debt obligation for) usually in the event that the borrower defaults. Being a guarantor can be a quick way to help a friend or family member purchase their home sooner which lenders often prefer, but before you jump in, you need to know what you are getting yourself into.
Family members or others who provide guarantees are taking a huge risk to their own property in providing a guarantee and in most cases we would not recommend that a person provide a guarantee. We are aware that it is common to do so and we therefore give this basic information about the nature of a guarantee and the procedure.
1. Providing Security
In most circumstances providing a guarantee for home lending requires you to pledge one of your assets as security for repayment of the loan. The lender will be securing the guarantee over at least one of your assets. This will usually be your own home or other valid security owned by you.
In these circumstances you will be offering the equity you have in a property you own which the borrower uses as additional security for their loan. The loan you are guarantying is then secured over both the property they are purchasing and your own property. By allowing this you are effectively increasing the equity the lender has (ie the difference between the loan amount and the security values) and this helps the borrower by minimising the amount they need to contribute to the purchase. A further cost saving to the borrower can occur as the guarantee usually reduces the lending ratio to below 80% of the security values which also means the borrower can save thousands of dollars by not having to pay lenders mortgage insurance.
You will be agreeing to allow the lender to register a mortgage on your title. Guarantors need to realise they will no longer “own their own home” or have a “freehold title”. They will be providing security and accepting the risk of default in the similar manner they would have if they had taken out the mortgage for their own benefit.
The extent of the guarantee you are providing also has to be properly understood. In some instances the bank can agree to provde a guarantee limited to a certain sum of money, or a certain sum in addition to default costs. This is preferable to an unlimited guarantee (when the bank could use your guarantee to allow further or other borrowing or mortgage increases).
2. Solicitors Certificate
The lender will often ask you to see a solicitor for independent advice on the guarantee and sign a solicitors certificate which is a declaration to the bank to ensure the lender that the solicitor has explained the guarantee to you and the solicitor believes you understand what is involved in providing the guarantee. Providing this advice can take a considerable period of time and all of the documentation has to be provided as the lawyer is having to certify that they believe the guarantor understands the advice they are being given, often meaning that they understand every clause of complex loan and mortgage documents. Most solicitors in South Australia will not sign this certificate (including lawyers in our firm) and you will need to seek the advice of one of the limited practitioners who will if you do want to consider providing a guarantee.
Obtaining a solicitors certificate is often both time and cost prohibitive and any contract for sale and purchase signed by a purchaser that relies on a guarantee should keep this in mind when setting the time frame for settlement. This is especially important when there is a subject to finance special condition as often only a small time frame is set between finance approval and settlement. Where a solicitors certificate is required the process for obtaining the certificate can delay the processing of loan documentation and the ultimate mortgage drawdown significantly. If it is not carefully contemplated it can result in penalty interest being charged to the purchase for a delay in settlement and breach of contract.
3. What happens if you want to provide guarantee for more than one family member
This can occur when parents with more than one child want to provide a guarantee for two or more of their children. Depending on the lender and how much equity you have in the property you are using as security you may not be able to provide guarantee for more than one person.
Most lenders are only happy to accept a guarantee security if they are going to be registered as the first mortgagee on a title. For those people that have one property, say their own home, to provide as security it is likely that only one of your family members would be able to have you guarantee their loan.
In the event a lender allows you to use the same security for a second or third property, all lenders involved will likely be required to enter into a “deed of priority” which sets out the order in which each lender is able to recover against the guarantee title. The deed of priority is signed by all involved lenders and the preparation costs involved with preparing this deed will be an extra cost borne by the borrower. The process of arranging the deed of priority can also be time prohibitive and this will need to be considered by the parties when setting contractual time frames for settlement.
4. What happens if the person you provided guarantee for defaults on their mortgage
This is the biggest and most concerning risk to any guarantor. If the borrower is unable to repay the loan you may be required to make the repayments for them or risk losing your own home. Some guarantee documents also can insist on payment from you, or repayment of the loan in full, even if the loan is not in default. You have to remember that your guarantee and indemnity is a separate and independent obligation between you and the bank, irrespective of what happens with the borrower.
Firstly, in the event of default, it is important (where you can) that you encourage the borrower contact the bank to explain their inability to pay the loan and try to seek some assistance by way of either a hardship grant or stop payment. In the event the non-payment continues the borrower will need to sell the property to pay off the bank and if they are not complying with the bank requests to list the property for sale the bank may seek a court order to enforce the sale. Ultimately, even if the bank has not taken direct action against you before this time, if there are insufficient funds from the sale of the property to pay off the mortgage then the property you provided as guarantee to secure the loan may also need to be sold unless you can repay the arrears and costs in full
If you have guaranteed a loan for someone and they are in default or appear they may soon be required to default, you need to seek expert legal advice immediately so that you can protect your interests. We also recommend that you keep yourself informed about the borrower’s payment of the debt so that you are aware as soon as possible of any payment difficulties. If there are likely to be defaults it is in your interest to act quickly to ensure the debt is repaid by the borrower, even if it means you taking action to make sure the sale of their assets occurs sooner.
5. What happens if you decide to sell the property you guaranteed security over
Even if you owned your own home without any mortgage prior to providing guarantee you will generally not be able to sell your guaranteed property without either repaying the guaranteed loan in part or in full or providing some kind of substitute security for the lending bank.
The usual options a bank will consider in this situation are;
- You pay down the guaranteed loan by the sum of the guarantee with the profits of your sale. For example if you guaranteed a certain percentage of the loan you could pay that amount in cash to the lender and in exchange they would release your guarantee and discharge their mortgage over the guarantee property at settlement.
- Upon sale of the property the bank may agree to hold onto a sum of money from the sale as a replacement for the property security in a term deposit under your name. This is generally able to be held as an interest earning term deposit, however, not all lenders provide this option and you will need to negotiate directly with the lender.
- If it is a simultaneous settlement (you are selling your home and purchasing a new one at the same time) you may be able to transfer the guarantee over to the new property you are purchasing. You will need to make sure you provide relevant instructions to your banker or broker as soon as you list your current house for sale as they will need time to prepare a discharge of the current mortgage and an application for new mortgage and guarantee over your new home. In most circumstances you will also be required to complete the solicitor certificate and guarantee period process again.
There are a number of possible solutions for a person buying a home other than providing your house as security under a guarantee. One might be simply to ask them to wait a period of time. Another might be to lend them a sum of money which allows them to reach the debt to equity ratio the bank needs to allow them to purchase without a guarantee. This has the advantage of limiting your exposure to the amount you have lent them. We would recommend that any person considering providing a guarantee get some good financial advice about their circumstances , the risks and whether it is the right thing for them to do.
Johnston Withers Lawyers and Conveyancers
Johnston Withers Lawyers and Conveyancers are highly skilled in advising on and negotiating contractual time frames that will allow for a seamless conveyancing transaction where a guarantee is involved and we remain committed to providing our clients with relevant and current information relating to conveyancing trends and settlement of loans and contracts. We are also able to provide advice to a potential guarantor about any liabilities that arise, in arrangements with the borrowers and in drawing up of loan and other documents in the event that funds are loaned to a borrower to avoid a guarantee being entered into.