Love can be blind when going guarantor for an adult child’s loan for a business venture or to help them get on the property ladder. But parents who let their emotions override good sense can end up servicing the loan or having to sell their house if the offspring’s business goes bust. It can pull families apart.

A guarantor undertakes to pay another person’s loan should they be unable to do so. Going guarantor is a legally binding agreement with the lender.

When a parent, or anyone else, is asked to go guarantor, they need to understand the implications. If a lender requires a guarantee, it’s because they think the risks of lending to the borrower are significant.

For a mortgage over a property, the likelihood of a lender asking for a guarantee is less than for a business loan, as the lender has the property as security.

Anyone buying property with less than a 20 per cent deposit will have to pay for mortgage insurance, which, although paid by the borrower, covers the lender for any shortfall that may occur when the property is later sold. However, some lenders allow a family member to use equity in their house as extra security for a mortgage. That way, the borrower with only a small or no deposit can avoid mortgage insurance, the premium for which costs thousands of dollars and goes onto the mortgage.

The principal solicitor of the Consumer Credit Legal Centre (NSW), Katherine Lane, says parents should never go guarantor for their child’s loan. ”Just say no,” she says. The reason: going guarantor almost always involves risking an asset – usually the guarantor’s home.

”The only time that it’s all right to go guarantor is if you have assets, such as an investment property, that you can afford to lose,” she says.

There are alternatives.

If the parents have money they can afford to do without, they can give it to the child, or, better still, lend it to them and draw up a loan agreement, Lane says.

A financial planner and director of WLM Financial Services, Laura Menschik, says there’s a difference in risk between repaying a mortgage on a house and repaying a loan on a business venture.

”If it’s for business, you’re backing the person’s potential to run a business, repay the loan, and make good on any legal agreements they have entered into,” she says.

Menschik suggests calling a trusted outsider to go over the business plan. She has had clients who have agreed to go guarantor, but only if they are able to have some control of, or insight into, the business. For example, the guarantor may require the accountant to regularly report to them on how the business is going.

Lane says she has seen clients who have never spoken to their children again after a dispute over money. ”I think family relationships are miles too important to put at risk,” she says.

Even where the adult child has equity in their own home, the lender can go after the guarantor’s house first, Lane says.

”It is up to the lender; they take security so they can sell whatever they like,” she says. ”Lenders are usually reasonable, but the guarantor’s house can be sold first.”

Lane adds that if the lender goes to court, it takes both the borrower and guarantor

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Posted by John Collett – The Age on 3rd March, 2013