WHAT PARENTS NEED TO KNOW BEFORE BECOMING A GUARANTOR
It can be hard to get a home loan nowadays and countless young people feel locked out of the property market.
Heeding the prime minister’s words, many older folks have taken on the role of loan guarantor for their children.
While this has helped scores of young adults achieve their goals, it has also left countless older Australians facing an uncertain financial future – often without even realising it!
If a borrower is unable to pay back the loan according to the terms of the contract, the lender can take legal action against the guarantor.
The guarantor will be liable for the amount specified in the guarantee.
While they are liable for part of the loan, the guarantor does not have the legal right to take ownership of the property or any items purchased with the loan.
And, if they have used their own property as security against the loan, the bank may be able to repossess it to pay off the borrower’s debt.
This could be a risky position to be in, especially with retirement nearing.
Graham Turnbull is a Senior finance strategist for Zinger Finance. He says, many people don’t realise what they are getting themselves into when signing on as guarantor.
He says, it is very important to get legal advice from a trusted solicitor before entering into the agreement.
Guarantors should carefully check what they are getting into before signing on the dotted line.
DID YOU KNOW?
There are two different kinds of guarantees.
– A limited guarantee allows the guarantor to cover a fixed amount of the borrower’s debt in the event they can’t pay it back.
– A full guarantee means the guarantor is responsible for repaying the entire debt if the borrower cannot or will not do it themselves.
Adding a guarantor to a loan may attract extra fees and charges. This is because it makes the whole loan application process much lengthier than it would be otherwise.
When a guarantor is added to a loan application, the approval process becomes much more involved.
Since this takes much more time than a standard loan application, the additional cost is usually passed onto the applicant in the form of extra fees and charges.
TWO TYPES OF GUARANTEE
Graham says, most people who act as guarantor don’t even realise there are two types of guarantees.
If you sign up as guarantor without stipulating exactly how much you will cover, the banks will hold you accountable for the entire loan.
If, for example, you agree to cover $50,000 of the loan – then, you will be accountable for this amount and no more.
- Acting as a guarantor may affect your Centrelink entitlements.
- If you wish to apply for finance yourself, being a guarantor will affect your own borrowing power.
WHAT ABOUT YOUR FINANCIAL HEALTH?
According to Graham, guaranteeing someone else’s loan has the power to seriously impact your financial position.
He says, while every case is different, lenders will generally see your guarantee as a liability in their serviceability calculations.
In other words, if you want to apply for a loan, the amount you are liable to pay in the case of the borrower defaulting will be calculated as repayments and added into your expenses.
If you are receiving Centrelink payments, the value of the asset may be included in your eligibility test. This may mean your payments get reduced or even stop.
You may never have to put a cent into the borrower’s loan – yet, your guarantee will be seen as a liability by lenders and as an income-producing asset by Centrelink.
WHAT ABOUT YOUR FUTURE PLANS?
If you are nearing retirement, or are planning on applying for finance, becoming a guarantor may not be the best option.
In the event that you do have to pay out the borrower’s loan, will you be able to make the repayments without causing financial strain? How many years will this take?
Or, will you end up needing to sell your own home to pay it back?
WILL YOU DISH OUT TOUGH LOVE?
Not only does being a guarantor affect your financial position, it may also have a serious impact on your relationship with the borrower.
You will be required to sign off on anything loan related. For instance, if your child wants to release a part of their loan to buy a new car, they will require your approval.
This may put you in a difficult position.
WHAT ABOUT OTHER OPTIONS?
Graham says, lending the money for a deposit is a safer option because it means you will not be liable for the borrower’s debt.
Or, if cash is not available, withdrawing a fixed amount of equity from the family home may be a solution. Handing this over as cash will enable you to help the borrower without putting your home at risk.
Otherwise, the choice is really up to you. While many parents want to help their kids crack the market. It is important they consider their own financial health too – especially if they are nearing retirement.
However, if you still wish to guarantee someone else’s loan, make sure you ask yourself the following questions first:
– What are the legal implications of the agreement?
– How will being a guarantor affect my financial position?
– What are the fees and charges involved?
– Will this affect my plans for retirement?
– How will this impact my income?
– Can I afford to pay off the debt without needing to sell any assets?
– Will this put a strain on my relationship with the borrower?
If you would like to to a finance strategist about you or your children’s property finance needs, contact Zinger Finance.