The Hidden Risks of Guaranteeing a Home Loan
When Lily and Noel needed a guarantor to secure their first home loan, they turned to family. But a conversation with their lawyer opened Sam and Riley’s eyes to the serious financial risks involved in guaranteeing someone else’s debt. This story highlights the importance of understanding loan guarantees before making commitments.
Lily and Noel wanted to buy their first home, but their bank told them they wouldn’t give them a loan unless they had someone else guarantee their borrowings.
Their bank told them that since they were intending to borrow $600,000, they would require an unlimited guarantee. They asked Lily’s brother Sam and his partner Riley if they could guarantee their lending.
Lily and Noel were confident they would be able to pay their mortgage repayments and told Sam and Riley it was “more of a formality with the bank”. One of Riley’s friends suggested they see their lawyer to talk about the risks involved in giving a guarantee.
Their lawyer met with Sam and Riley and explained the nature of the guarantee. Sam and Riley had bought their own home ten years ago and had paid down a good proportion of their mortgage. Sam and Riley were therefore shocked to learn that by giving a guarantee, the bank would be able to take security over their home and possess it if Lily and Noel couldn’t meet their repayment obligations. They also discovered that actually, the bank could come to Sam and Riley before going to Lily and Noel to repay the loan.
Their lawyer advised that they should not give the guarantee as they would essentially be stepping into the shoes of someone else’s borrowings and taking on their financial risk. She also explained the “chain of guarantees”; that if Lily and Noel decided to guarantee someone else with the same bank, Sam and Riley (and their home) would be tied into that new guarantee as well. Their lawyer also advised that the unlimited guarantee meant that Sam and Riley were liable for an unlimited amount, and that Lily and Noel (or any other guaranteed party) could also borrow further funds from the bank without telling Sam and Riley.
Sam and Riley still wanted to help out Lily and Noel, so asked their lawyer to negotiate a limited guarantee with the bank.
This would be limited to only a portion of Lily and Noel’s borrowings and Sam and Riley felt comfortable that they would be helping Lily ad Noel onto the property ladder, but with reduced risk to themselves.
When thinking about giving a guarantee to anyone, even family or friends, it is crucial that you speak to a lawyer.
If you feel you could use some specialist advice, don’t hesitate to contact the Property Team.
