Given the way property has moved over the last few years, prices having increased by up to 30% in some areas, young people have found it increasingly difficult to enter the property market.
Sometimes, in addition to their own resources, banks will impose conditions upon young prospective borrowers that entail them turning to the bank of mum and dad.
Parents are able to assist their children getting into the property market in a number of ways including by:
1. providing funds; and
2. providing a guarantee
If you are in the position where you have insufficient spare funds to be able to provide assistance to your children, then the rest of this article probably isn’t relevant. However, if you are being called upon to provide a guarantee, then it will also be the case that you will be called upon to provide a mortgage over your property.
A personal guarantee is a promise made by one person (person one) that another person (person two) will meet their financial obligations to person three and if person two doesn’t, then person one will pay person three. Usually, a personal guarantee also includes an indemnity, which means that person three has the benefit of a promise from person one that they will not suffer any loss by reason of person two’s failure to pay.
Guarantees (and indemnities) are usually supported by a mortgage over land. In the case of bank of mum and dad, that usually means the family home.
Most of us are aware that if you fail to pay your mortgage then the lender has certain rights to enter the mortgage property, recover it from you and then sell it in order to repay their debt.
The same applies when granting a mortgage to support a guarantee. If your children do not pay their loan obligations and you are unable to meet any demand made by the lender following that default, then the lender will be entitled, under the terms of the guarantee and the mortgage, to enter and recover possession of your principal place of residence (if that is what’s been mortgaged) and sell it. They can do so even though they may also have that same right in relation to your children’s property. In other words, your principal place of residence, if that is what you have mortgaged, is at risk. They can use the funds to pay the debt plus, any interest, fees and charges payable under the loan.
Lenders almost uniformly now insist that parents giving a guarantee and mortgage in respect of their children’s financial obligations must obtain independent legal advice. The reason for that relates to the case from the 1980s in which elderly Italian migrants with limited English skills, little formal education, and little business experience, were asked to guarantee their son’s business loans. The business went bust and the bank sought payment from the elderly parents.
The court found they signed the documents in circumstances that the court found were unconscionable and as a result, the lender in that instance was unable to enforce the guarantee and the mortgage.
In order to avoid allegations of unconscionable conduct, lenders have since insisted that people obtain independent legal advice in those circumstances. Please note, the lenders are not doing that for the guarantor’s benefit, but rather for their own.
Guarantors are asked to obtain independent legal advice so the bank is confident the guarantee and mortgage will be enforced against them. The guarantor cannot say they did not understand the obligations they were undertaking and that the circumstances surrounding the grant of the guarantee and mortgage were not unconscionable.
Accordingly, we strongly advise clients in these circumstances to ensure:
1. they know the risks — they can lose their home;
2. they understand the nature of the obligations they are assuming — to pay if their children don’t; and
3. they are doing so voluntarily with full knowledge of the financial circumstances and the risk they are assuming.
The practical effect of the above is that in addition to legal advice, guarantors should also obtain financial advice so is to ensure that they understand all of the financial circumstances surrounding the parties they are guaranteeing.
Parental love is strong, and parents always want to do the best they can do for their children, but they should not do so recklessly.
If you are ever called upon to give a guarantee for a loved one, please call Hadyn Oriti, Donovan Oates Hannaford on 6583 0449 for further information.
Direct Phone: (02) 6583 0449