Helping people and businesses acquire assets is a big part of what we do at Complete Legal. Often, that process involves some sort of loan or other finance, and with it comes a concept many people have heard of but few fully understand: the personal guarantee.
Whether you are a company director being asked to personally back a business loan, or a parent helping a child buy their first home, understanding what a personal guarantee involves is essential before you sign anything.
When do personal guarantees come up?
There are two common scenarios where personal guarantees arise.
Company borrowing: If you control a company that is borrowing money from a bank or financial institution to acquire an asset or fund a business venture, it is likely that the lender will require personal guarantees from the directors of the company.
Residential property purchases: Sometimes a purchaser will not have enough deposit to satisfy the lender’s required loan-to-value ratio (LVR) without triggering a requirement to take out lender’s mortgage insurance (LMI). Banks and lenders require you to have a certain percentage of the value of the property you are purchasing in cash. To waive some of these conditions, a bank or lender may accept a personal guarantee from an individual or individuals related to the borrower.
Similarly, in a business context, while the percentages may differ, lenders will usually require you to have a certain percentage of the business asset you are acquiring, or offer security other than the asset itself, in order to advance your loan.
What is a personal guarantee?
A personal guarantee is a promise made by an individual who is not the borrower that, should the borrower fail to meet its obligations to repay the loan, the guarantor will step in and either satisfy the debt themselves, or in the case of a limited guarantee, satisfy the debt up to a pre-agreed limit.
The key point to understand is this: the guarantor’s personal assets are at risk if they do not make good the borrower’s obligations under the relevant loan agreement. This includes assets such as the guarantor’s home, cash at bank and any other assets.
Why are personal guarantees so common in property?
As a result of an ever-robust property market, personal guarantees, often provided by parents, have become a very common way for first home buyers to get into the market. Without a guarantee, many buyers would otherwise be locked out for a long period of time because they do not have sufficient savings to meet the lender’s LVR requirements, or they would incur the often significant cost of lender’s mortgage insurance.
Personal guarantees in business lending
In the context of business lending, personal guarantees serve as a safeguard for the lender in circumstances where companies may have little or no assets which can be used to satisfy any judgment, should a lender have to pursue the company for not repaying a loan.
What should you do before going guarantor?
If you are considering providing a personal guarantee of any kind, you need legal advice to understand what you are signing up to.
If you are considering guaranteeing the obligation of someone other than yourself, for example going guarantor for a child or relative purchasing real estate, you also need to satisfy yourself as best you can that they are likely able to meet the loan repayments they will be required to make.
You should ask the borrower questions about their income, and how they would fund any increase in their repayments, for example as a result of an interest rate rise. If you are putting your assets at risk for someone else’s benefit, you need to have as much information about the transaction as you possibly can.
Get advice before you commit
A personal guarantee is a serious legal and financial commitment. Before you sign, make sure you understand exactly what is involved and what is at stake.
Contact our experienced team to discuss your situation and get clear, practical advice on your obligations as a guarantor.
