Third-party security and guarantees explained

When the business does not own enough property

Plenty of sound businesses own no real estate at all. The premises are leased, the equipment is financed and the directors rent or have little equity in their own homes. When a secured loan is the right answer, the security has to come from somewhere, and the most common source is someone close to the business: a parent, a spouse, a sibling, a business partner or a related company that holds property.

That property is called third-party security. It does not belong to the borrower, but its owner agrees to let a lender register a mortgage or caveat over it to support the loan. In return, the owner takes on real risk, and the lender takes on the duty to make sure the owner knows what they are agreeing to.

How the documents work

Most third-party arrangements involve two documents signed by the property owner:

• A mortgage over their property in favour of the lender. This can be a first mortgage if the property is unencumbered, or a second mortgage behind an existing home loan.
• A guarantee that the borrower will meet its obligations, sometimes paired with an indemnity.

The guarantee is the part people most often misunderstand. Some guarantees are limited to the amount recovered from the mortgaged property. Others are unlimited, which means the guarantor could be pursued for any shortfall from their other assets as well. Neither is unusual, but the owner must know which they are signing.

Independent legal advice

Almost every lender requires the third party to obtain independent legal advice from a solicitor who does not act for the borrower or the lender. The solicitor explains the documents, confirms the owner is acting freely and signs a certificate saying the advice was given. This is not a formality. It protects the owner from pressure, and it protects the loan from later claims that the owner did not understand or was unduly influenced.

Expect the lender to ask that the borrower is not in the room when advice is given. Allow time for this step, because finding a solicitor and booking an appointment can take a few days, especially if the owner lives in a regional area.

What lenders look at

When third-party property is involved, a lender considers the same things it would for any secured loan, plus some extras:

• The property’s value, location and type, and any existing mortgage on it
• The relationship between the owner and the borrower, and whether the owner benefits from the loan
• The owner’s age and circumstances, including whether it is their only home
• Whether the owner is receiving any benefit, such as an equity stake in the business
• The exit strategy and how long the third party’s property will remain encumbered

Where the owner is elderly or the property is their only home, some lenders apply extra caution or will not proceed. That is responsible practice rather than a judgement about the business.

Related companies and trusts

Third-party security does not always come from family. A related company or a family trust that holds an investment property can offer it as security, with the company or trustee signing the mortgage and guarantee. The lender will want to see the trust deed or company constitution to confirm the trustee or directors have the power to give the security, and it may want every director or trustee to sign. Our guide to borrowing through a trust covers the paperwork in more detail.

Planning the release

The best third-party arrangements have a clear end. Before signing, agree how the owner’s property will be released. Common release triggers include:

• Repaying the loan in full from a sale or refinance
• Reducing the loan below a set amount, after which the lender relies on other security
• Substituting another property, such as one the business later buys

Write the plan down and share it with the owner. A guarantor who knows when their property will be freed is far more comfortable than one left wondering.

Illustrative example

A café owner needs funds to clear an ATO debt and fit out a second site. She rents her home and owns no other property. Her parents own their house outright and agree to support the loan. The lender registers a first mortgage over the parents’ home, and the parents each sign a guarantee limited to the property. Both see a solicitor separately and sign the advice certificates. The loan term is twelve months, with the plan to refinance into a bank facility secured over the café’s equipment and trading history once the ATO debt is cleared and a full year of clean statements is available. On refinance, the parents’ mortgage is discharged.

This example is illustrative only. Every scenario is assessed on its own facts.

Risks to discuss openly

Third-party security can strain relationships if things go wrong. Before asking someone to help, be honest about:

• What happens if the business cannot repay, including the possibility of a forced sale
• How long their property will be tied up
• Whether they can still refinance or sell their own property while the mortgage is in place
• Who pays legal costs, including the cost of their independent advice

A family member who agrees with full information is in a much better position than one who agrees out of loyalty without understanding the downside.

Alternatives to consider

If third-party security feels too risky, consider whether a smaller loan secured on a director’s own home or a second mortgage behind an existing loan would do the job. Sometimes staging the borrowing, or combining a smaller secured loan with a payment plan, avoids involving anyone else at all.

Getting started

If someone close to your business is willing to help, check your eligibility with no credit check. Tell us who owns the property, roughly what it is worth and what is owed on it, and we will explain how a lender is likely to structure the loan and what the owner will need to sign.

Start your enquiry when you are ready.