Getting out of a personal loan guarantee is hard.
A loan guarantee is like the proverbial straight jacket. Both are very hard to get out of.
Sometimes banks and other lenders will only make a loan, if someone else provides a personal guarantee that they will repay it, if the borrower does not.
It is such a serious thing to do that lenders send prospective guarantors off for legal advice so they understand the risks and ramifications of signing a guarantee, including just how long they may be bound by it.
And it is back to lawyers guarantors must go when they want out of those guarantees.
Lawyers say being able to get out of a guarantee can depend on the type of guarantee a person signed.
If it was a "limited" guarantee over a single loan, it can be easy.
Once a personal loan covered by a limited guarantee is repaid, the guarantee can be discharged. Similarly, parents who guaranteed a portion of a child's home loan should see that discharged once equity in the place exceeds 20 per cent.
But lawyers say the majority of guarantees are "unlimited", under which the guarantor may be required to repay all current and future debts the borrower incurs to the lender.
Unlimited guarantees can hang around for years, one recent Banking Ombudsman case showed.
A man found himself responsible for paying business debts thanks to a personal guarantee he had signed 10 years' before. He believed once the original debt was cleared, the guarantee would be discharged. It hadn't been, and it was the subsequent debts he ended up liable for.
Lawyers would always prefer clients' guarantees were limited, with a clear end to the guarantee signalled from the start, but that is rare. Arranging finance is a commercial negotiation. The borrower wants the money, so the power lies with the bank, and it wants security.
Tammy McLeod from Davenports Law said: "It can be difficult to negotiate with banks, to be honest, but we do try to limit guarantees".
Stu Barraclough from GQ Law said: "In my experience, when somebody goes to them for a loan, they will go for as much security as they can get their hands on".
Broadly people go personal guarantor on one of two broad categories of loan.
The first is on loans in which the guarantor has a personal financial interest, such as the businessman whose plight the Banking Ombudsman reported on, personally guaranteeing a bank loan to his own business.
The other kind is when the guarantor has no immediate personal financial interest, for example, guaranteeing a business loan for a relative, or to help a child into a first home.
Avoiding the first is hard if you own a business, or are the trustee of a family trust with borrowings.
Avoiding the second is as easy as saying no, which as the financial benefits flow to someone else, can often be the best choice.
Barraclough said extinguishing a personal guarantee was often a matter of "requesting" it from a lender. The request could be refused, if the lender believed it would damage its security. In some cases, the bank might agree provided other security was offered.
The quick guide on the Banking Ombudsman's website says: "Generally speaking, you can cancel a guarantee at any time."
"However, this does not release you from the guarantee. The cancellation only freezes your liability at the amount of the guaranteed debt when you asked for it to be cancelled," according to the guide.
McLeod doubts people who have given unlimited guarantees can freeze their liabilities as the guarantees were taken to protect the banks from both current and future borrowings of the individual whose debts were guaranteed. "You can't unless the bank agrees to it."
Barraclough said even if a bank agreed to cancel a guarantee, it could immediately result in the entire loan becoming payable.
The Ombudsman agreed: "Even after you do this (cancel), the bank can require you to pay the guaranteed debt that existed at the time you cancelled the guarantee (including any interest and costs)."
Banking ombudsman Nicola Sladden said: "Our understanding is that generally banks will allow the guarantee to be cancelled. However, this does not necessarily release the guarantor from all their obligations under it. Cancelling the guarantee may also have consequences for the borrower, if alternative security is not obtained."
She advised a guarantor who wanted to cancel a contract to contact their bank directly, or a lawyer.
When it all goes wrong.
When a borrower fails to repay a loan on which someone else is a guarantor, the results can be disastrous, a case heard by the Financial Dispute Resolution complaints scheme shows
In the case, a man was faced with losing his home as a result of his son's business failed, and all as a result of a $10,000 loan.
The man's son had borrowed the money from a finance company three years before, and the man had guaranteed he would repay it, if his son didn't. Because it was a business loan, the man had agreed the Credit Contracts and Consumer Finance Act.
The loan was to prop up the son's struggling business.
Unfortunately, the business continued to make a loss, and the loan had spiralled to $55,000. The finance company demanded payment from the man. He didn't have the money, and so faced mortgagee sale.
Financial Dispute Resolution couldn't help as the finance company hadn't been a member of its complaints scheme when the guarantee was signed, but it reviewed the case and believed the finance company was acting within its rights.
This article was written for Stuff.co.nz by Tammy McLeod.
For further Trust Law advice, get in touch with Tammy and the Trust Law team.
tammy@davenportslaw.co.nz | 09 883 4420
