Going guarantor for a relative or a friend could put your most valuable asset on the line.
John and Nadia Abdelkodous, a couple from Casula in Sydney, borrowed $494,000 from Adelaide Bank in 2001 to help their son buy a house. Nine years later, they were in court fighting to stop a default order against them.
The couple offered their Casula home as security for the loan, which allowed their son Victor to buy a house in Prestons. The bank started default proceedings in 2005 and the parents took over the repayments until 2009, when they found themselves unable to continue to do so.
Last year, the bank obtained a default judgment and the parents sought to set it aside, claiming their son had forged their signatures.
In February, the NSW Supreme Court set the default judgment aside and allowed the parents to file a defence of fraud.
Spate of cases
A spate of cases involving disputes over loan guarantees have been in court recently and many have features in common with the Abdelkodous case.
A guarantee is where you promise to repay the loan if the borrower does not. The lender will ask for a guarantee when it thinks the borrower might have difficulty repaying the loan. If the borrower does not make all the payments under the loan contract, the guarantor will have to pay back the outstanding amount plus interest and any fees and charges.
What recent cases show is that people who give guarantees are often older and lack financial understanding. Their home is often their only asset and they have limited income, so if the lender calls on them to honour their guarantee, they are almost certainly going to be in trouble.
Fraud, or the suggestion of fraud, is often a feature.
Should be banned
Matthew Bransgrove is a partner at Bransgrove Lawyers, which specialises in mortgage and finance litigation. He says he would not recommend anyone be a guarantor.
”From all the cases we have seen, it is hard not to conclude that they don’t serve any useful purpose,” he says. ”I think they should be banned, especially where the guarantee is used to support a business loan. If people are going into business, they should be able to put together a business plan that does not involve getting their parents to give them a guarantee.”
Bransgrove says there has been a trend in the courts during the past few years to set loans aside in cases where the judge felt the guarantor was a vulnerable person and the lender should have made more inquiries before accepting the guarantee.
”A lot of these arrangements are based purely on the value of the guarantor’s asset,” he says. ”The courts are saying that lenders have to do a bit more work than that. But the reality is that more often than not the court does not set the loan aside and the guarantor has to make up the payments for the defaulting borrower.”
Bransgrove says there are cases in which the guarantor has signed false statements, knowingly or not, or been involved in some other fraud to help the borrower. In those cases, the courts are not sympathetic: ”If you are seeking relief, you have to be blameless yourself.”
According to the Consumer Credit Legal Centre (NSW), many people report that they feel pressured into signing a guarantee and they do so unwillingly.
The principal solicitor, Katherine Lane, says to consider other options before committing to a guarantee.
”Perhaps you could give the borrower an interest-free loan of a few thousand dollars, which they could use as a deposit,” she says. ”You could offer to help them start a savings plan by matching their savings.”
Loan guarantor case file
Fast Fix Loans v Mladenko Samardzic. The parents were on an age pension, of non-English speaking background, had received very little education and were manual labourers most of their lives.
The son ran a property development company and needed additional funding. He arranged for the parents to mortgage their unencumbered property as additional security.
The court found that the parents understood the commitment they were making and were prepared to take the risk because they trusted their son. However, the court ruled that the loan be set aside.
It was “improvident” because the lender was aware of the difficult financial position of the son’s company at the time and was therefore aware of his limited ability to repay the loan. The lender didn’t make inquiries as to the parents’ ability to repay, either.
Source: Bransgroves Lawyers
What to do before going guarantor
???????????????????????? Check the borrower has a regular source of income that is sufficient to repay the loan.
???????????????????????? If you are planning to go guarantor for a business, ask for the most recent financial statement and get an independent opinion from an accountant.
???????????????????????? Look at your own finances and make sure you are able to make the repayments if something goes wrong with the borrower. Would you need to sell assets?
???????????????????????? Talk to the lender to make sure you know exactly how much it is that you are guaranteeing. Also, confirm that the lender cannot change the amount guaranteed without your consent.
???????????????????????? Make sure you get a copy of the loan contract, which should include the amount of the loan, the interest rate, the term and the amount of monthly loan repayments.
???????????????????????? Beware of guaranteeing loans that are not scheduled to be repaid. These include overdrafts and line-of-credit loans. In theory, guarantees on these types of loans can go on forever.
Source: Consumer Credit Legal Centre (NSW).