The new Banking Code of Practice (BCOP) mandates procedures for situations where joint borrowers will not obtain a ‘substantial benefit’. However, there is a threshold question of whether a person should be a borrower at all.
It is likely that the principles set out in BCOP will be considered best practice by AFCA, courts, and regulators and so this report raises issues which are relevant to all lenders and not just ADIs who subscribe to BCOP.
Clauses 54 and 55 of BCOP provides that if borrowers will not receive a substantial benefit from the loan, lenders should ensure that (amongst other things) they have taken into account why the customer wants to be a co-borrower and that the customers understand the risks they are taking.
When co-borrowers are spouses or de facto, there is sufficient benefit in being a borrower even if the property is owned by only one of the co-borrowers so long as the asset (eg home, car) is for joint use. This is because the law will normally protect spouses and de factos in relation to asset splits upon relationship breakdown.
In the absence of a spouse/de facto situation, the relationship between the co-borrowers can be easily terminated by one borrower, leaving the co-borrower liable for a debt for which they are receiving no benefit. Further, they do not have the benefit of the law that protects spouses and de factos. Accordingly, substantial benefit will usually be unclear in these circumstances.
However, if a customer is not receiving money or the use of a joint asset from a loan, the person cannot properly be categorised as a borrower. This person should be a guarantor, and may escape liability altogether if incorrectly treated as a borrower.
Sometimes parents are made joint owners of real estate (and so joint borrowers) so that their earnings can be taken into account in the loan assessment. However, there is a risk that the parents have no ‘real’ ownership and instead are holding their share in the property on trust for the children so that in due course the title can be transferred to the children without paying stamp duty. If they receive none of the money or benefit of the money, they should not be borrowers.
Proportionate ownership and being a co-borrower is appropriate if the parents will genuinely own a share of the property or borrow money which they lend or gift to their children
The fact that a person is incorrectly categorised as a borrower is likely not to be rectified by taking the ‘remedial’ steps in clause 54 of BCOP.
RG209 negated the ‘urban myth’ that a guarantor’s income cannot be taken into account when assessing a loan. RG209.32 deals with ‘indirect income’ and it is clear that taking into account the income of a person who will be supporting the borrower is acceptable so long as this arrangement is verified and acknowledged by the contributor. We recommend that guarantors who are likely to be required to make regular payments sign an acknowledgment to that effect.
It is important to remember the restrictions on recovery against guarantors in the National Credit Code and clauses 113-115 of BCOP.
Against this background, Dentons has developed some workable guidelines for the finance industry.
We appreciate that taking personal guarantees can add to process complications, but there is risk in not doing so when the person is correctly classified as a guarantor and not a borrower.
1. Work out who are the borrowers. Who is the advance being paid to or on behalf of?
2. Any persons other than borrowers providing financial support must be guarantors.
3. If guarantors are expected to contribute regularly to repayments, obtain an acknowledgment of that fact.
4. If a co-borrower owns only a small proportion (say 30% or less) of the asset being acquired by the loan obtain a Joint and Several Liability Acknowledgement.
5. If a co-borrower is providing a large proportion (say 70% or more) of the security to support a loan made to all borrowers, obtain a High Security Acknowledgement.