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Pros and cons of being a guarantor

Before looking at the pros and cons of guarantees let me first set the scene.

We sign guarantees to underwrite the ability of someone (often a loved one, close friend, or even a business partner) to borrow money or enter into a legal arrangement, which creates hefty obligations for the person you are guaranteeing.

I’ve interviewed more guarantors than I wish to remember and, more often than not, they believed they were morally ‘supporting’ the person rather than actually ‘underwriting them’ in a cold, unforgiving financial sense.

So why do banks, landlords and financiers ask for guarantees? There is no rocket science here. Put simply, the ‘big brother’ in this scenario doubts your loved one can honour their legal and financial obligations. If they didn’t have the doubt, there would be no need for a guarantee. And if they fail in their obligations, big brother wants to be able to call on you to make good for them. So in reality, a guarantor is big brother’s insurance policy. Their safety net.

A request for a guarantee should ring very loud alarm bells. The question isn’t, ‘Should I do this because I love the person or feel obligated because they asked me, and they need me?’ The questions should be:

  • Why is a guarantee required?
  • What is the risk that I may be called upon to pay out money under the guarantee?
  • If called on to pay out, can I afford the payment without causing myself serious financial hardship?

 

And I’ll let you in on something. A reassurance (with or without a reassuring cuddle) from your loved one (or the big brother for that matter) that ‘it will be fine, you have nothing to worry about, it’s just a formality’ is reason alone to say “No”.

If you have objectively assessed the risk after proper investigation and you can afford to pay out if a call is made on the guarantee – then by all means go ahead, lend all the support you can afford. If you don’t tick both these boxes consider the alternative … use your wealth to buy lottery tickets.

Am I ‘anti bank’ or anti ‘big brother’ – absolutely not. I have worked for such organisations and I understand how they work. The danger is, many guarantors don’t.

Giving a guarantee is a serious, potentially dangerous financial transaction, not a loving gesture of good will.

The upside of providing a guarantee (the ‘pro’ if you will) is that you can help someone achieve something they can’t without you, whether a new home, a new business or a new… anything.

The down side (‘con’) is that if things go pear shaped and you can’t afford to pay-out the required money, then your loved one’s problem becomes yours.

After working as an insolvency lawyer for decades, both for and against banks, I have developed a very cynical attitude – if someone signs a guarantee after I’ve explained it to them, I’ve failed to explain it properly.

Cynicism aside, guarantees play a valuable role as they often enable people to ‘get a start’ or ‘get ahead’. That’s a plus. Assess any request you receive, and if you are satisfied the ‘odds’ are good and you can afford ‘the hit’ if it comes – go for it.

The danger is that people agree to give guarantees without understanding the risk and not assessing whether they can honour a call under the guarantee without destroying their own financial position. They don’t focus on the reality, that things can and do go wrong.

I’ve been involved with too many parents losing their homes and savings, and living their twilight years in poverty, not to have very strong views about this issue.

My advice is: make the assessments and be prepared to say ‘no’. Do not say ‘no forever’ because the next request might be for something more affordable for both parties. Reassessing and resetting expectations is part of the process of negotiating whether you provide a guarantee.

Remember: divorce isn’t the only cause of sexually transmitted debt. Being overzealous to help family and friends with a guarantee is equally disastrous.

If you learned a lot from reading Rod’s article, then you should hear him speak! See him and other YourLifeChoices’ experts live at the Sydney Retirement Bootcamp on 15 July and you could have your own questions answered on retirement, estate planning and much more.

Related articles:
Should she be a beneficiary?
Blocking inheritance of the family home

YourLifeChoices Writers
YourLifeChoices Writershttp://www.yourlifechoices.com.au/
YourLifeChoices' team of writers specialise in content that helps Australian over-50s make better decisions about wealth, health, travel and life. It's all in the name. For 22 years, we've been helping older Australians live their best lives.
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