Why do banks mandate a guarantor to acquire loans? If the loan fails to repay, the guarantor shall be accountable for fulfilling the borrower’s obligations. A guarantor is also known as a surety. Also, the guarantor sometimes keeps his personal belongings as security for repayment.
Simply put, a person who takes a guarantee from someone else to fulfill their promise of repaying the borrowed loan amount is known as a Guarantor in financial terms. Therefore, you must know the person well before accepting to be anyone’s guarantor. As this is not just a formality or requirement of the lending institute, you shall be equally liable for repayment.
So, let us begin by understanding who a guarantor is, what responsibilities are attached to it, and under what circumstances parents can act as guarantors.
1. Who is a Guarantor?
A Guarantor is a person who gives a guarantee against any loan, mortgage, or debt taken by someone else. The guarantor promises to repay the amount taken by the third party in case this third party fails to fulfill its commitment to repaying the amount borrowed.
A parent, relative, close family member, or friend usually acts as a guarantor. It is implausible that any person you just met a couple of times acts as a guarantor for you.
1.1. Let Us Understand Better With the Following Example
XYZ (Borrower) has borrowed a certain amount from a Bank (Lender). ABC (Guarantor) is responsible for acting as a Guarantor of XYZ (Borrower). A guarantee can be for the partial amount or the full amount. In case XYZ (Borrower) makes a default in monthly repayments, in such a scenario, the Bank (Lender) will come after ABC (Guarantor) to fulfill the interest payment obligation on behalf of XYZ(Borrower).
1.2. Attributes of a Guarantor
The Guarantor might have to keep his property as collateral against the loan/ mortgage amount. The Guarantor needs to enter into a Deed of Guarantee, a contract that contains all the terms and conditions and should be duly signed by the Guarantor. There is a difference between a guarantor and a co-borrower. The co-borrower is primarily liable for the loan repayments. However, the guarantor does not have to pay until there is a default on the borrower.
There are various types of guarantors. For instance, financial/ non-financial guarantors, personal/ corporate guarantors, mortgage guarantors, and so on. Guarantors are liable for legal action in case of default. It’s difficult to back out once you sign on as a guarantor. It involves consent from both parties. Also, there should be a substitute guarantor in place before you withdraw.
2. What is Guarantor Mortgage?
When you have a guarantor mortgage, you might get a mortgage loan without keeping any sort of deposit or having a decent credit history to fetch one. Under a guarantor mortgage, someone else’s property is kept as security for a mortgage by the mortgage lender.
In case of default in mortgage repayments, the mortgage lender has the authority to sell the property kept as security. The mortgage guarantor has no ownership of the property purchased from the mortgage loan taken by the borrower.
Usually, guarantor mortgages are someone close to the borrower, like family and friends. Also, only some people and not everyone can be a mortgage of guarantor mortgages.
To fulfill the criteria, the guarantor must be an adult, above 18 or 21, with a stable income source and strong financial conditions. The guarantor should have a good credit score. Sometimes, the guarantor must own a residence or a specific equity. However, the requirements can vary depending on factors such as the guarantor’s age, property location, and many more.
2.1. Advantages of Guarantor Mortgages
Guarantor mortgages help in getting a bigger loan than the borrower would have received if applied alone. If the borrower has a bad credit history, the guarantor mortgagor can become a savior in obtaining the desired loan amount.
2.2. Disadvantages of Guarantor Mortgages
Finding someone with a strong financial backup willing to help you might be difficult. Financials might negatively impact the relationship between borrower and guarantor if there’s any default in repayment. The interest rates on guarantor mortgages are usually seen to be on the higher side when compared to regular mortgages.
3. Parent as a Guarantor
There are typically two types of guarantors: personal guarantors and corporate guarantors. Parent guarantor act as a parenting company, thus they come under the category of corporate guarantors.
Lately, it has been observed that property prices are reaching the sky. So, buying a home has become extremely challenging. Also, people in their early stages of life do not have that kind of financial status or means to invest in property, especially housing property.
Here, the parents come into the picture as they can become guarantors for loan payments for their kids, and most lending institutes demand that either parents or close relatives agree on becoming guarantors to lend money.
In layman’s language, it’s a parental guarantee given to the lending institute that, in default, if made by their offspring, they shall be liable to fulfill their wards’ obligation.
This is because parents are usually well established with a good amount of cash deposit in the bank. Also, they can keep their property secure to repay their children’s mortgage loans.
3.1. Criteria for Parents to Become Guarantors
Parent Guarantors must own a property, i.e., they should be homeowners or at least have the majority of equity in the property, which shall be kept as security. They should have good financial footing and credit history. Parent Guarantors should not have any defaults in repayments.
3.2. Consequences of Becoming a Guarantor
Becoming a guarantor involves huge potential risk, so it is always advisable to explore options and take independent legal advice from a lawyer to safeguard the guarantor’s interest.
It’s important to analyze and set limits; instead of giving a guarantee on the complete loan amount, become a guarantor of a certain portion. This will also ensure that children don’t underestimate your genuine help.
A parent guarantor should discuss the terms and timeline with their child openly. Over time, depending on the loan terms and the borrower’s financial condition, there might be a possibility for the guarantor to exit the mortgage agreement legally.
Under certain conditions, a guarantor might be required to pay the loan default. Thus, if possible, create a savings account with fixed deposits instead of keeping your property secure. In this case, you are safer as this fixed deposit can be used for repayment in the case of default. And in case there is no default, you can earn interest on the fixed deposit.
3.3. Risks Involved
In case of default made by the child in mortgage repayments, the ill effect will not only be seen in the child’s credit score, but also the parent’s credit score might have an impact. Because of this, getting a loan in the future might be tricky.
Usually, parents are in the phase of retirement, or some might have even retired. Putting their life-long earnings at risk might cause unfavourable circumstances in the event of default in repayment. Before accepting to become a guarantor, you must assess your future loan requirements. Becoming a guarantor can impact that.
The lender might even drag the parent guarantor to court for the fulfillment of repayment obligation. Once you become a guarantor, it’s very difficult to withdraw. Unless agreed by both borrower and lender.
4. Alternative of Becoming a Parent Guarantor
There are huge risks and liabilities involved in becoming a guarantor. Hence, it should be seen as a final option. Following are the alternatives that Parents might resort to help their children:
4.1. Cash Gift
If you have sufficient cash deposit in your bank, try giving your kid a portion of it, which can be used as a down payment. In this way, the mortgage loan amount might be reduced considerably.
4.2. Joint Borrower Sole Proprietor Mortgage (JBSP)
The Joint Borrower Sole Proprietor Mortgage concept has lately been gaining popularity in the property market due to the advantages attached to it. As the name suggests, there are multiple borrowers, but only one shall be the sole owner of the property.
This is useful for first-time buyers who don’t have great financial stability or credit score to bag in the lumpsum amount of a mortgage loan. The joint borrower is usually parents or guardians who want to help their children yet do not want their names on the title deed of the property.
The joint borrowers can also withdraw their names as soon as the child can handle the loan amount alone. However, they need to undergo the process of remortgaging and legal qualifications. Under JBSP mortgage, the financials of the joint borrower are also taken into consideration, making it easier to get the desired loan amount.
4.3. Help Them in Managing Their Financials
If nothing works, you can always help them save. Instead of buying a new property, allow your children to reside with you for a certain period wherein they can save. It involves sharing financial conditions with them to understand the necessities of investments, savings, and income delegation strategies. This would lead them to financial maturity.
4.4. Purchase the House Yourself
If you have sufficient funds, you can pay to buy the house, let your children stay there, and take monthly rent from them. Once you have the property deeds and recovered the desired purchase amount, you could transfer the property to your kid through legal procedures of property gifting or as a trust if they are under 18.
5. Busting the Myths of Being a Guarantor
The following are the most common myths revolving around this topic:
5.1. Can Retired Parents Take Up the Responsibility of Mortgage Guarantors?
Well, that is completely at the discretion of the Lender. However, most of the time, mortgage lenders consider retired parents as guarantors if they fulfill the criteria. Generally, these criteria are that parents should be financially sound or have sufficient income, they should own property, they should have stable and regular income from pensions, or they should have good bank deposits.
5.2. Can Parent Guarantor Withdraw as Mortage Guarantor?
Yes, but it’s a complex process. To withdraw from the capacity of the guarantor, there needs to be mutual understanding and consent from both the lender and the borrower. Also, in case of repayment of the partial loan amount, the lender might accept the request of the parent guarantor to withdraw itself from the position of guarantor.
5.3. Is There Any Time Limit for the Guarantor to Stay on Mortgage?
Guarantors are typically required until the loan is paid off or specific conditions are met, and their responsibility may cease under certain circumstances.
6. Wrapping Up The Journey
It simply implies that guarantors give a guarantee on your child’s behalf. Parents should analyze their child’s potential before agreeing to become a guarantor. Becoming a guarantor for home buyers is a risky affair accompanied by significant responsibilities. There are serious legal implications attached to it. However, if you are confident about your rights and have understood the intricacies and your child’s capacity, you can support your child to their first home.
However, you should also be prepared for any future uncertainty. Before securing your child’s future, make sure you are guarded and backed up with an alternate plan in case of any default.
Last Updated on by Arnab