Posted June 2017 by NZCU Baywide
Everything you need to know before signing on the dotted line
There’s no denying Kiwis are a helpful bunch!
But what would you say if a friend or relative asked you to act as guarantor on their next personal loan?
Facing mounting debts and skyrocketing house prices, guarantor loans are an increasingly popular option among parents looking to help their kids break into the property market.
But would you even know what you’re signing up for?
Today we’re helping to answer this question, filling you in on all things guarantor so you can make an informed decision that’s right for you and your financial future. This includes:
- How unlimited guarantees could trip you up.
- The difference between being a co-borrower and a guarantor.
- The ways things can - and do - go wrong.
- Why you could have a harder time getting a loan of your own.
- The many ways you could put your credit score at risk.
But first, let’s get you up to speed on what a guarantor is...
Hold up, what is a guarantor?
If you’re unsure what a guarantor is, here’s the lowdown:
Banks and Credit Unions offer lower interest - and higher approval - rates to applicants who have a third party - that’s you! - act as additional security.
Think of it as a safety net for the lender, and a vote of confidence for the applicant.
In fact, it’s a great way to get a loan if the applicant:
- Has a large amount of debt or a low credit score.
- Doesn’t meet the requirements for a secured loan.
- Wants to access a lower interest rate or higher loan amount.
Alright, enough about the benefits for everyone else...what’s in it for you?
A pat on the back and the eternal gratitude of your friends or family is one thing, but being a guarantor could also leave you at risk.
Chief among these, you could be saddled with the repayments if the borrower falls behind.
So what should your response be? Are your concerns justified? And how risky is it really?
To start, we’re looking at the pitfalls of unlimited guarantees…
1. Beware unlimited guarantees - they could trip you up
Signing on as a guarantor couldn’t be simpler.
You just sign on the dotted line!
Right? Wrong! There's actually more to it than just scribbling your signature.
For starters, you need to consider the particulars of the agreement itself.
The most common guarantee is what’s known as an ‘unlimited guarantee’, which makes you jointly responsible for any subsequent borrowings or liabilities that the borrower may enter into.
If you’re still unsure how this works, consider this scenario:
You’ve just signed on as a guarantor for your friend’s loan. A home loan, in fact! Having bought their first home, it’s an exciting time for all involved. As the years go by, however, your friend decides to increase this loan in order to finance some much-needed home renovations.
In this case? You’d be responsible for the initial amount and the later increase.
That’s why it’s important that you look for a ‘limited guarantee’ whenever possible.
These agreements are offered by most New Zealand financial institutions, providing you with increased protections as well as a limit on:
- The amount you’re liable for.
- The length of time you’re held responsible.
So when it comes to signing on the dotted line? Make sure you know exactly what you’re signing up for: do your homework, check the fine print, and ask questions. It can be awfully difficult to get out of a guarantee once you’re committed.
2. Co-borrower or guarantor? Get to know the difference
It can be all too easy at times to confuse the roles of ‘co-borrower’ and ‘guarantor’.
However, there is a big difference between the two.
In most cases, a co-borrower is someone who has a deep financial interest in the assets that are being used to secure it, and is jointly responsible for the entire amount of the loan.
For example, yourself and your partner might apply as co-borrowers on a personal loan for a new vehicle. This would see the both of you sharing equal responsibility for paying back the loan amount in full.
A guarantor, on the other hand, is only linked to the loan.
That is, they’re not responsible for making repayments until such a point that the borrower fails to meet their financial obligations.
- A co-borrower is responsible for repayments from day one, as it’s partly their loan.
- A guarantor is only responsible for repayments if the borrower is unable to repay the loan in full.
3. Things can - and do - go wrong
Chances are the borrower asking you to guarantee their loan is a close friend or family member.
They’ve always been trustworthy.
They have a great financial record.
What’s more? They’ve said they could repay the loan in next to no time.
So what’s the worry, right?
We think you’ll agree that trying to predict your own financial future is difficult enough, let alone that of someone else.
Breakups? Business failures? The loss of a job? Any number of unexpected circumstances could see an otherwise financially responsible borrower defaulting on their loan and leave you to pick up the pieces.
As the saying goes, ‘It’s better to be safe than sorry’.
No, you might not be able to predict what’s to come, but you should prepare for all possible outcomes.
What would happen, for example, if push came to shove and you were left carrying the burden of someone else’s loan repayments?
Would you be able to cope?
4. Applying for a loan could be *that* much more difficult
You, more than anymore, know how tough it can be to manage your own finances at times.
The thing is, financial institutions know this too!
This is why stepping into the role of guarantor could make it that much more difficult for you to get a loan of your own in the future.
As a guarantor, you’re effectively taking responsibility for someone else’s finances in addition to your own.
Could you imagine juggling all of those bills, loans, and repayments at once?
Chances are you’re going to drop something eventually.
Unless, of course, you’re just great at juggling!
Circus performers aside, most New Zealanders just like you would struggle to make ends meet if they had to keep up with additional repayments each and every month.
Seeing this increased risk, a lender would be well within their rights to decide that you won’t be able to make repayments on another loan if the worst were to come to pass. And if it did? You might have to repay the guaranteed loan in full before you apply for a new loan of your own.
5. You could tank your credit score
When you sign on the dotted line as a guarantor, this is recorded in your credit report.
If the original lender defaults on the loan you’ve guaranteed, this is also recorded as lenders look to you for repayment.
We’ve talked at length in the past about how this credit report is used by financial institutions to measure your eligibility for anything from a loan application through to signing up for certain utilities.
A default as the result of a guaranteed loan gone bad could put you at risk of hurting your credit score, not to mention risk further marks on your record if you’re unable to meet these unexpected repayments.
With your credit score on the decline, it would be that much more difficult to apply for finance to consolidate your debts, or at the very least see you paying a higher interest rate on any loans you are approved for.
Still can’t decide? Here’s 7 questions every guarantor should ask:
Still can’t decide if being a guarantor is worth the risk?
To make the decision easier, here’s a few questions you should ask yourself before you sign on the dotted line.
- What would you be willing to risk as security, and how would you feel if that item was repossessed if the money can’t be paid back?
- Is the borrower financially responsible, and do you feel they’re capable of repaying the loan?
- What are the reasons the borrower requires you to be a guarantor in the first place? Are they self-employed? Do they have a poor credit score?
- Is the loan a sensible one, and would you apply for a similar one if you were in there situation?
- Could they save with a high interest savings account or a term deposit instead?
- Do they really need a secured loan, or could an unsecured personal loan work just as well?
- Would you be able to repay the loan in full - including any interest - if the borrower is unable to do so?
Being a loan guarantor isn’t without risks, so read up!
We opened this post by pointing out just what a helpful bunch Kiwis can be.
That’s because it’s true!
But before you jump in feet first for a friend in need, you should read up and get informed of the benefits and risks you might face when acting as a loan guarantor.
With a little planning, preparation, and the points we’ve covered today, you’ll be able to make the right decision for your friends, family, and most importantly yourself if the question ever crops up.