Guaranteed loans – they’ve become more prevalent as house prices rise, and as access to business credit changes – but this type of loan can come with significant risk depending on how it’s set up. It often requires a savvy, credit-educated person to sign on the dotted line to take on a guaranteed loan. But this isn’t always the type of person asked to sign a guarantee. In response to some complaints by guarantors who claim they have not been given the appropriate advice, a survey was issued to banks to review their compliance with the Code of Banking Practice by its review body, the Code Compliance Monitoring Committee. We examine the findings of this survey, and put guaranteed loans into perspective with the possible implications to the guarantor’s credit file.
By Graham Doessel, Founder and CEO of MyCRA Credit Rating Repair and www.fixmybadcredit.com.au.
Guaranteed loans can be complicated, and can leave some individuals vulnerable. The Code of Banking Practice has identified this, and has set out requirements for banks in dealing with the area of guaranteed loans (28.3-28.6 of the Code of Banking Practice) which include requiring banks to issue prospective guarantors a warning notice explaining their rights and obligations as a guarantor. Banks also can’t accept a guarantee until the guarantor has sought independent advice.
But has this been enough to protect individuals who find themselves asked to guarantee a loan? The Code Compliance Monitoring Committee (CCMC) has found more can be done by banks to promote better compliance, and ultimately better understanding by individuals of the risks involved in guaranteeing a loan.
The CCMC is an independent review body for banks’ compliance to the Code of Banking Practice. According to the CCMC report on guaranteed loans, the body undertook a survey of banks due to a number of allegations of breaches of the Code by banks:
“During 2011-2012, the CCMC received a number of concerns and enquiries about alleged breaches of the Code by banks in this area,” the report states.
The CCMC identified a need going forward to ensure compliance, and better compliance by banks to the Code concerning guaranteed loans. It considered the economic climate will likely continue to provide an environment where guaranteed loans will rise:
“The high number of credit facilities currently supported by a Guarantee indicates that these play an important part in the provision of credit, both to individuals and to businesses. Issues can and do arise however when banks do not comply with their own procedures. While the number of cases where issues have arisen in respect of Guarantees is comparatively small, the impact on individuals in these circumstances can be considerable. The current economic environment also suggests that this may continue to be an important issue over the short to medium term. This is a view shared by the consumer advocates interviewed by the CCMC as part of this Inquiry.”
The CCMC’s report demonstrates that overall banks were meeting the requirements of the Code by having good systems and procedures in place, and were monitoring those systems. But it also found that some banks could do more. It cited some good industry practices amongst some banks that could be applied across the board to ensure prospective guarantors were making informed decisions. The CCMC says it recognises that banks have an important role in ensuring relevant information if both provided and considered by prospective guarantors prior to the execution of the Guarantee:
“The Code sets out the minimum standards banks have agreed to follow when dealing with personal and small business customers. Banks should, therefore, consider how they satisfy themselves that informed decision making is taking place, particularly where they identify that a prospective guarantor might be vulnerable, whether due to their relationship with the borrower or where they have limited capacity to understand the credit contact, such as where English is a second language. The CCMC also considers that the more complex the Guarantee and the loan documentation, the greater is the obligation on the bank to ensure the potential guarantor engages in informed decision making.
The CCMC accepts, however, that there is a duty on the individual to consider carefully the information provided by banks before agreeing to become a guarantor,” it states.
Disclosures of information and warnings were considered imperative to the guarantor making an informed decision about becoming a guarantor. The CCMC recommended banks ensure that information and notices are provided to the prospective guarantor in a timely manner to ensure they have sufficient time to consider their position and the risks associated with the Guarantee prior to execution.
This will ensure that the prospective guarantor has sufficient time to consider the risks and financial liabilities of becoming a guarantor before entering into the agreement.
Good industry practice suggests that even a prospective guarantor who has received independent advice, should be given at least 24 hours to consider the Guarantee documents prior to signing.
This will increase the prospective guarantor’s opportunity to consider the risks and financial liabilities of becoming a guarantor in the context of the independent advice given, before entering into the agreement.
They also brought up the need for banks to consider the vulnerability of a prospective guarantor:
“Banks which have effective processes to identify classes of prospective guarantors and take additional steps to ensure they receive information about their rights and responsibilities and the financial position of the borrower, are better placed to comply with their Code obligations.”
These vulnerable individuals may include elderly people, non-English speakers and people who offer a family home as collateral. The CCMC will follow up this Inquiry in the 2013/14 Annual Compliance Statement, to determine what changes, if any, banks have implemented to systems and procedures in response to the findings of the survey.
Earlier in the year, we reported that some banks had begun to relax requirements around guaranteed loans to include a new term – Security Guarantee. This meant the guarantor would no longer have to be a parent, sibling or spouse of the borrower. But identified at the time, were some significant risks to this loan which arguably far outweigh the benefits.
On a guaranteed loan the guarantor is liable for the debt if the borrower fails to make repayments. The guarantor’s credit rating is then linked with the credit rating of the borrower through the loan, despite having little control over the outcome of repayments.
If the debtor defaults on their loan, under certain terms the Credit Provider can pursue the guarantor to recover the debt, which can include default listing the guarantor. Negative entries such as defaults on a person’s credit file will impact the ability to obtain credit for 5 years.
In cases of significant arrears, the bank begins to use the property the guarantor put forward as collateral to recover the outstanding debts.
It is timely that the CCMC should review banking procedures in this area. The upward trend in guaranteed loans may increase the exposure of vulnerable individuals to guaranteed loans in their many forms.
It is imperative that all facilitators take on an educational role – despite it ultimately being the decision of the guarantor themselves. Further education at that level will help to identify more who are vulnerable, and protect those who may not be fully informed of their rights, their obligations and the risks to their finances and their credit file before entering a guaranteed loan.
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