Collateral required as guarantee of loan repayment
The purpose of a guarantee or pledge given in security for a loan is to secure repayment to the lender, ie the creditor. Although the loan decision is primarily based on the loan applicant’s repayment capacity, the collateral provided in security for the loan is also important.
The following covers the main principles on a general level. As the guarantor or pledgor’s liability for the loan is defined in the collateral agreement, it is essential that he/she understands the terms and conditions of the agreement, thoroughly. The bank bears the responsility of clarifying the contents of the agreement with the guarantor or pledor.
In housing loans, the collateral is usually the residential property being purchased
When taking out a housing loan, the property itself is typically the collateral for the debt. A guarantee or pledge given by an external private person in connection with a housing loan is a ‘deficiency guarantee’. If the debtor fails to repay the loan, the loan principal can be collected from the guarantor or pledgor only if the debtor’s residential property serving as collateral does not fully cover the debt repayment.
Guarantor’s liability for a loan according to the collateral agreement
In issuing a guarantee, the guarantor, on the basis of personal property, assumes liability for a loan or an agreed amount. If the guarantee is a directly enforceable guarantee, the creditor may collect the debt directly from the guarantor.
There may be several guarantors, in which case each guarantor is jointly and severally liable for the debt. Any one of the guarantors can be ordered to pay an overdue debt. If the guarantor must pay the debt, he/she is entitled to collect from the debtor any amount paid to the creditor on the basis of the guarantee. The guarantor has the same right vis-à-vis the other joint and several guarantors, according to the per capita shares of the debt for such amount of the principle to be paid, above their own respective share.
A private customer applying for a loan in order to purchase an owner-occupied home may also receive a government guarantee for the loan. Banks intermediate government guarantees in connection with their housing loan decisions. A government-guaranteed housing loan may account for a maximum of 85% of the purchase price of the home or the cost estimate for the construction of a detached house. For more information on government guarantees, see the right hand margin.
Pledgor’s property as security for a loan
In connection with pledging, the debtor or another person gives his/her property as security for a loan. If the loan is not repaid, the creditor may sell the property given for security for the loan and use the sales proceeds for loan repayment.
The creditor determines independently the value of property given as security for a loan. The collateral value is not the same as the market value of the property. In general, for example, the bank sets the collateral value of real property or housing company shares by deducting a certain safety margin from their market value. This ensures that, should the market value of the property decline somewhat, loan repayment will not be jeopardised. However, the bank cannot require additional collateral from a private customer because of a normal reduction in the value of the collateral.
In addition to housing company shares and real property, banks also accept, for example, deposits and listed shares as collateral. In general, the collateral value calculated by the bank for these types of assets has a certain safety margin deducted from their market value.
The bank has an obligation to provide information to guarantor or pledgor
Prior to conclusion of the contract, the creditor must provide the guarantor and pledgor with information eg on the debts for which the collateral serves as security and on such commitments that the debtor has and other matters relating to his/her debt servicing capacity, which could be considered being of relevance to the guarantor or pledgor. The liability of the guarantor or pledgor can be adjusted if the creditor fails to comply with this disclosure obligation.
Before committing yourself to acting as a guarantor or give a pledge
Check the following details before you commit yourself to acting as a guarantor or give a pledge
- Verify from the debtor his/her financial position
- Clarify the content and scope of the guarantee or pledge agreement
- Make sure that all unclear points are cleared up before you sign the agreement
- If you are liable only for a portion of the debt or only for a certain period, make sure that these conditions are documented in the agreement
- Be sure you receive your own copies of the guarantee or pledge agreement and copies of the promissory notes, with repayment schedules, for which your guarantee or pledge is given. Keep them in a safe place
- Always be prepared for the possibility that you may become liable for the commitment you have undertaken
21 November 2012