If you are buying property in a company or in a bare trust for your self-managed super fund, your financier or lender will require you to provide a personal guarantee. This article will focus on personal guarantees in relation to secured loans, however there are several other instances where you may be required to provide a personal guarantee. So, what is a personal guarantee? It is a legal commitment where an individual agrees to be responsible for a debt or obligation if the primary borrower fails to meet their financial obligations. While personal guarantees can provide access to financing, they also expose guarantors to significant financial risks.
Personal guarantees generally fall into three categories:
- Limited to a Specific Amount
- Limited to Property as Security
- Unlimited guarantees.
Understanding the differences between these three types is crucial to making informed financial decisions.
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Personal Guarantees Limited to a Specific Amount
A limited personal guarantee sets a maximum amount the guarantor is liable for if the borrower defaults. This amount is clearly defined in the agreement and provides a cap on the financial exposure of the guarantor.
For example, if a business takes out a loan of $200,000, the director may provide a personal guarantee limited to $50,000. If the business defaults, the guarantor is only responsible for repaying up to $50,000 plus costs as outlined in the agreement, regardless of the remaining balance on the loan.
Key Features:
- Liability is restricted to a pre-agreed amount.
- Provides certainty and limits financial risk.
- Often used in business loans and supplier agreements.
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Personal Guarantees Limited to Property
A property-limited personal guarantee allows the lender to secure the debt against a specific asset, typically real estate that is being used as the security for the loan. This means that if the borrower defaults, the lender has the right to enforce payment through the sale or claim over the property.
For instance, in the context of self-managed super funds (SMSFs) buying in a bare trust or a company loan, the property being property brought by the bare trust will be used as security. If the SMSF or company fails to meet its obligations, the lender can take legal action to recover the outstanding amount by taking possession of the property but they are only able to claim the outstanding amount from the property.
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Personal Guarantees unlimited
An unlimited personal guarantee is as the name suggests a personal guarantee to be fully responsible for the mortgage if the borrower fails to comply with their obligations.
Why Legal Advice is Essential
A lender may require you to provide two different types of guarantees so while the directors of the SMSF trust required to provide a guarantee that is limited to a property, it is likely that you will also need to provide a guarantee limited to the full amount of the mortgage.
It is important to appreciate that getting independent legal advice is not just to fulfil a requirement of the lender, but it is to ensure that you fully understand the risks involved, what your obligations are and how much you will be liable for.
For expert legal advice on personal guarantees and risk assessment, contact NB Property Law Office.