A guarantee is a promise by a person (guarantor) to settle a debt or fulfil the promise of someone else.
Guarantees are required by a bank or other lending institution to ensure that the liabilities of a borrower will be met. They are useful financial tools and are commonly used across a range of transactions. However, guaranteeing someone else’s debt can expose you to significant risk and it is vital that you understand the implications of what you are entering into.
Before agreeing to act as a guarantor, the first question a potential guarantor should always ask is why is a guarantee required? This may be the first indication that the lender has concerns about the ability of the borrower to repay a loan.
If you do decide to enter into a guarantee, be aware:
- Guarantees are not usually limited to a specific advance from the lender to the borrower. Guarantees generally guarantee all the obligations the borrower may have to the lender.
- The lender does not need to inform guarantors if the borrower takes out more debt. This can mean the guarantor can end up guaranteeing a much larger debt that initially anticipated.
- A guarantee is not always the ‘last option’ for lenders in seeking repayment of an outstanding debt. The lender does not need to try and get their money back from the borrower first, and the lender often chooses which guarantor(s) they will seek repayment from. However, if the lender receives payment from one guarantor only, that guarantor may have the right to seek contributions from the borrower and any other guarantors.
- If the guarantor is also a customer of the lender (ie. the guarantor also has a bank account with the lender), then the lender usually has the right to appropriate funds from that account in order to recover any amounts payable under the guarantee.
- Where a guarantor has granted an ‘all obligations mortgage’ (which is the standard mortgage security for New Zealand banks and lending institutions) to the lender as security for a loan made to the guarantor (eg. your typical home loan), that mortgage security will extend to the debts for which the guarantor has given a guarantee to the lender.
Guarantees can be a complex area, and legal advice must be sought before entering into them. Additionally, if you are already a guarantor and you wish to discuss your position, we strongly advise you contact your lawyer.