Loan agreements and mortgages can come with significant legal and financial risks, and it is important to fully understand the terms of an agreement before entering into it.
In some situations, a lender will require a borrower to have somebody guarantee payment of a loan, known as a personal guarantee, and so they will draw up a separate guarantee contract which will bind the guarantor to the terms of the mortgage.
What does it mean to guarantee a mortgage?
In the context of a mortgage, a guarantee means that the guarantor will be guaranteeing the borrower’s performance of their obligations under the mortgage agreement. This means that if the borrower fails to make repayments as required under the loan, the lender can instead require the guarantor to make the payments that are required on the mortgage.
Personal guarantees can be for the whole of the loan amount (including interest and enforcement expenses), or can be for just part of the loan amount, which is referred to as a limited guarantee. The type of guarantee will depend on the circumstances of the loan and the lender’s requirements.
Parents acting as guarantors on mortgages
With Sydney property prices skyrocketing in recent years, it is more and more common to see guarantor mortgages for first time buyers. This typically occurs where parents want to help their children get into the property market, in circumstances where their children might not have enough saved for a deposit. Mortgage guarantee arrangements can also be used to remove the need for the borrower to pay for Lender’s Mortgage Insurance, which is normally required by lenders when the borrower is providing less than a 20% deposit, and which can cost tens of thousands of dollars.
Helping children get a home loan with a guarantor does come with risks for the guarantor, and so it is usually a requirement of the lender that the guarantor must obtain independent legal advice on the guarantee and loan documents associated with the mortgage.
Personal guarantees for company mortgages
When buying property using a company, it is often a requirement of the lender that the directors of the company provide personal guarantees for performance of the company’s obligations under the loan agreement. This is often because a special purpose company might have been set up to purchase a particular property and may have no other assets. Accordingly, the lender will want certainty that somebody else will guarantee performance of the loan agreement if the company fails to do so.
Personal guarantees on mortgages are also commonly seen when using other structures to purchase property, such as a discretionary trust or a self-managed super fund.
What is involved in guaranteeing a mortgage?
The lender will usually assess the financial standing of the guarantor, just as they would do with the borrower. This includes understanding their assets and liabilities, their income and expenses, and their overall ability to repay the loan in case the borrower is unable to.
It is often a condition that the guarantor will need to obtain independent legal advice, and independent financial advice on the mortgage obligations that they are guaranteeing.
Sometimes the lender might also take security over assets of the guarantor, such as by registering a mortgage or charge over a property owned by the guarantor.
Who can be a guarantor on a home loan?
For a home loan, a guarantor is usually a family member. While it often tends to be a parent, it can also be a grandparent, sibling, spouse, or child. Different lenders will have different policies on this.
Personal guarantees on business loans
Often a guarantor might also need to obtain independent legal advice when providing a personal guarantee on a business loan contract. This might have nothing to do with a property purchase, but could instead be related to cash flow financing, asset purchases, or even business acquisitions.
Independent legal advice for guarantors
When guaranteeing any kind of loan or mortgage, it is important that the guarantor fully understands the risks associated with the personal guarantee they are providing. The lender will often require a solicitor to read the loan and guarantee documents, explain them to the guarantor, and provide a certificate of independent legal advice in confirmation that independent legal advice on the mortgage or loan has been provided.
What is a mortgage indemnity?
As part of the document package required to be signed by a guarantor, there will often be a ‘guarantee and indemnity’ to be signed by the borrower. While we have covered the concept of a guarantee, it is important to also understand the meaning of a mortgage indemnity.
In the context of guaranteeing a mortgage or loan agreement, an indemnity is a promise that the guarantor will compensate a lender for any losses suffered by them as a result of the borrower’s default of the loan contract.
Things to check before agreeing to a mortgage guarantee
It’s important that a guarantor understands the financial circumstances of the borrower and their ability to make repayments or meet any other conditions of the mortgage. In order to properly do that, the guarantor must understand the terms and conditions of the mortgage, including the length of the mortgage, the interest rate, how the interest rate might change over time, and what other fees and charges might apply to the loan.
In addition to this, the guarantor must have a good understanding of their own financial standing, and whether they will be able to repay the loan if the borrower defaults on their obligations.
The importance of legal advice for guarantors
Guaranteeing a mortgage can involve significant legal and financial risks. It is important that you seek independent legal advice to ensure that you fully understand your obligations.
As loans can last for many years, and mortgages often last for 30 years, it is important to receive legal advice and get a clear understanding of when you might be discharged of your guarantee obligations.
The cost of independent legal advice for guarantors
When getting independent legal advice for guarantors, the cost can vary substantially depending on the length and complexity of the loan documents, and what is involved in providing legal advice. For example, legal advice on documents prepared by a private lender for a commercial loan may be far more complicated than advice required on a parent guarantee for a home loan from a major bank. More complicated documents may even require your lawyer to reach out to the lender’s solicitors to negotiate changes to the loan and guarantee documents in order to protect your interests.
Thornton + King can provide independent legal advice on guarantee documents
Our specialist lawyers have decades of experience acting for guarantors, borrowers, and lenders in relation to mortgage and loan agreements. We understand the complexities associated with being a guarantor and the time pressures that can often be associated with mortgage guarantee arrangements. To speak with an expert, give us a call or submit an enquiry now.
