Understanding Family Guarantees | The benefits, the risks, and the importance of legal and financial advice
In today’s financial landscape, family guarantees have become a popular tool for helping loved ones secure loans. Whether it’s assisting a child in purchasing their first home or supporting a family member’s business venture, it can be a valuable resource. However, it’s crucial to understand the implications, benefits, and risks associated with this financial commitment.
In this article, we explore what a family guarantee is, its advantages, potential pitfalls, and why obtaining independent legal advice is essential before proceeding.
What is a family guarantee?
A family guarantee is a financial arrangement where a family member, often a parent, agrees to use their own assets as security for another family member’s loan. This guarantee can help the borrower secure a loan they might not otherwise qualify for, often due to insufficient deposit or credit history. The guarantor’s assets, typically the family home, are used as collateral, providing the lender with additional security.
Benefits of a family guarantee
- Increased borrowing capacity: One of the primary benefits of a family guarantee is that it can significantly increase the borrowing capacity of the loan applicant. This can be particularly beneficial for first-time homebuyers who may struggle to save a large deposit – particularly given the seemingly neverending surge in Sydney property prices.
- Avoiding lender’s mortgage insurance: By providing a family guarantee, borrowers can often avoid costly lender’s mortgage insurance (LMI), which is typically required when the deposit is less than 20% of the property’s value.
- Favourable loan terms: With the added security of a family guarantee, lenders may offer more favourable loan terms, such as lower interest rates or reduced fees.
- Supporting family members: A guarantee allows family members to support each other financially, helping them achieve significant life goals like home ownership or business expansion.
Potential risks of a family guarantee
- Financial liability: The most significant risk for guarantors is the financial liability they assume. If a borrower defaults on the loan, the guarantor is ultimately responsible for repaying the outstanding amount, which could lead to financial strain or loss of assets. It is important for guarantors to understand exactly how much they are guaranteeing. For example, the family guarantee may be limited to a particular dollar figure or may extend to the full debt owing from the borrower (plus reasonable interest, costs and expenses)
- Impact on credit rating: If the borrower defaults and the guarantor is unable to cover the repayments, it could negatively impact the guarantor’s credit rating, affecting their ability to secure future loans.
- Relationship strain: Financial arrangements can sometimes lead to tension or conflict within families, especially if the borrower struggles to meet their loan obligations.
- Complex legal implications: Family guarantees involve complex legal agreements that can have long-term implications. It’s essential to fully understand the terms and conditions before committing.
Why guarantors should obtain independent legal advice
Given the potential risks and complexities involved, it’s crucial for guarantors to seek independent legal advice before agreeing to a family guarantee. Here are some reasons why:
- Understanding legal obligations: A lawyer can help guarantors understand their legal obligations and the potential consequences of the guarantee agreement.
- Assessing financial risks: Legal advice can provide a clear assessment of the financial risks involved, helping guarantors make informed decisions.
- Negotiating terms: A lawyer can assist in negotiating the terms of the guarantee to ensure they are fair and reasonable (if required).
- Protecting personal interests: Independent legal advice ensures that the guarantor’s personal interests are protected, and they are not unduly exposed to financial risk.
What does this all mean for you?
A family guarantee can be a powerful tool for helping loved ones achieve their financial goals. However, it’s essential to weigh the benefits against the potential risks and to approach the arrangement with a clear understanding of the legal and financial implications.
By seeking independent legal advice, guarantors can ensure they are making informed decisions that protect their interests and support their family’s financial well-being.
Have you been asked to provide a family guarantee? Get in touch with us to ensure you fully understand your rights before you sign on the dotted line.
If you’ve been asked by a financial institution to provide a family guarantee, you should make it a point to get independent legal advice before you make this committment.
Our banking lawyers have advised many of Australia’s largest financial institutions on their guarantor documents and so, we understand them inside out. Get in touch with us today to book in an appointment to get independent legal advice on your guarantee documents.