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Inspired by the question My co-borrower wants her name removed from a 5 year mortgage contract :

Assume I am the debtor of a loan, and someone else agreed to guarantee/co-sign the loan for me.

If the guarantor later wants to be released from the guarantee, and the lender agrees, can I (as the debtor) prevent that release?


On the one hand, as far as I understand, a loan guarantee is an agreement between the lender and the guarantor. So as the borrower I am not part of the agreement, and therefore I would assume I do not get a say in how it is handled.

On the other hand, I may wish for the guarantee to continue, for example because I get better rates, or because I hope the creditor will go after the guarantee's money instead of after me. Is this a sufficient reason to ask for the guarantee to continue?

I am interested in answers for different jurisdictions, particularly for Germany.

  • Because the agreements are separate, the rates on the lenders agreement probably cannot be raised by the bank if the bank terminates the co-signing agreement. This would especially be the case if the second agreement is terminated for consideration. – MSalters Mar 10 '17 at 17:25
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UK-based answer:

In essence there are two separate agreements:

  1. A loan agreement between the borrower and the lender

  2. A guarantee agreement between the guarantor and the lender.

To answer your question, both parties in the 2nd (guarantee) agreement, can choose to terminate the guarantee contract. This is called discharge by agreement, and requires consent by both parties and consideration (i.e payment, a nominal fee would be enough)

Moving on with your question, you as a third party are not privy (directly involved) in the guarantee agreement, you are only involved in the original loan agreement, and therefore you cannot force them to follow the agreement.

In any case, even if they don't dissolve the guarantee agreement, if you are unable to pay the loan, the lender can always go for you first, and if you don't have enough money, the lender can go for the guarantor for the rest of the balance.

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As you say, the loan is between person A and the lender and the guarantee is between person B and the lender. Person A and B are free to make any contract they like providing it doesn't conflict with the contracts between them and the lender. However, unless Person A's contact with the lender says so, they cannot force the lender to enforce any rights they have against person B. If A defaults, the lender can call on the guarantor or not as they choose.

5

If the guarantor later wants to be released from the guarantee, and the lender agrees, can I (as the debtor) prevent that release?

Unless the loan agreement says otherwise, generally not, under U.S. law. This said, I can't recall ever seeing a lender agree to release a guarantor in the absence of a refinancing.

I may wish for the guarantee to continue, for example because I get better rates, or because I hope the creditor will go after the guarantee's money instead of after me. Is this a sufficient reason to ask for the guarantee to continue?

Unless your loan agreement with the lender was modified, I do not see why you would get a better rate if the loan continued. Normally the interest rate would be set in the loan agreement and would not be subject to modification.

Also, the bank is under no obligation to go after the guarantor instead of you even if the guarantor was not released. This is part of the reason that it makes sense that the lender could unilaterally release a guarantor.

The Bigger Issues

Unsecured Loans With Guarantors And Exceptions To General Rule

In a related post, you mention that the loan is a 5 year mortgage and that the mortgage is on a house owned 95% by you, and 5% by the guarantor.

This is a materially different situation that a guarantee of an unsecured loan that is discussed in my answer and the other answers to this question. The answer would probably be different in the case of a mortgage loan taken out by co-owners of the real estate.

The law is likely to be the same in the U.S. and the U.K. and Germany for a one-time, fixed or variable interest rate, fixed-term unsecured loan. But, there are likely to be a lot of differences between the U.S., the U.K., and Germany, respectively in the area of mortgage lending and in the area of revolving unsecured loans like credit cards.

The law is also likely to vary quite a bit from country to country if the borrower and the guarantor are in business together and the loan is for business purposes rather than for personal purposes.

A detailed review of the basic ground rules of real estate law and mortgage lending in Germany can be found here.

Mortgage Loans By Non-Business Co-Owners Of Property

A mortgage loan taken out by co-owners of real estate (who own 95% and 5% of the property respectively) involves two subtle but distinct ideas: One is an agreement to put the 5% co-owner's interest in the house up as collateral, the other is an agreement of the co-owner to have personal liability on the loan beyond putting the 5% co-ownership collateral at risk.

Also, if there is a mortgage signed by both a 95% owner and a 5% owner, usually you would not call either of them "guarantors" or "co-signers" of the loan. Instead, they would both usually be primary debtors on the loan.

Normally, a mortgage lender would absolutely insist on having all owners of the house that is collateral for the mortgage liable for the loan at all times. Otherwise, if they had to foreclose on the house due to non-payment, they would only get 95% of the house, with the other 5% of the house being co-owned by the co-owner with the lender.

So, if the co-owner doesn't agree to a mortgage, then it will be commercially impossible, even if it is not actually legally impossible, to get a loan against the remaining 95% of the house.

Indemnification Duties Of Co-Borrowers

Another subtle issue in that situation would be the duties of the co-owners to indemnify each other.

Vis-a-vis the bank, there would generally be joint and several liability, which is to say that the bank would have the right to collect 100% of the unpaid balance on the loan from either co-owner. (In the U.S. it is usually possible in theory for the lender to just sue either or both debtors personally for the loan balance if it is in default, rather than foreclosing on the house first and then suing on the deficiency as banks usually do, but this would not be true in every U.S. state or in every country.)

But, the law would vary quite a bit depending on the country and depending on the relationship, when it comes to the duties of the borrowers and guarantors to each other.

Usually, a guarantor has a right to sue the primary borrower for a reimbursement of any amount paid by the guarantor on the loan (which is called indemnification), although this right is usually pretty useless because usually a guarantor ends up having to pay the loan only if the primary borrower doesn't have an ability to pay.

In contrast, sometimes co-owners of property who are both primary borrowers would have no duty to seek indemnification from each other, and sometimes co-owners of property who are both primary borrowers would have a right to seek enough indemnification from the other co-owner/co-borrower based upon their relative percentage ownership in the property. (There are a couple of different distinct formulas for determining this amount: One allows indemnification on a 95-5 basis in this case for any amount paid. The other allows indemnification of the 95% owner only after that owner has paid more than 95% of the total loan debt, while the 5% owner could seek indemnification only after that owner has paid more than 5% of the total loan debt.)

Rights Of Co-Owners Of Real Estate In The United States

In the U.S., at least, one co-owner of real estate does not have a legal right to force the other co-owner to buy her out, in the absence of a written agreement to that effect.

(I wouldn't be surprised if German law on this point was different, as the laws of co-ownership of real estate in the U.S. have a lot of historical baggage and result in a lot of practical difficulties.)

Instead, in the U.S., either co-owner could bring a "partition action" which in the case of a home that is not amenable to being divided in kind would force the sale of the house by both parties in a public sale more or less identical to a foreclosure sale at which any proceeds would be first paid to the mortgage holder, and then to the co-owners in proportion to their ownership interest with an adjustment for an accounting of their relative investments in the property.

Rights of Co-Owners Of Real Estate In Germany

A number of persons, companies and other legal entities can be co-owners of the property. Such co-ownership may be subject to special agreements between the co-owners that restrain sale, transfer and/ or use. Most commonly, however, co-ownership can be ended by any co-owner at any time on request (Bruchteilsgemeinschaft). In such an event, the property must be sold and the sale can be enforced by public auction on demand by any party. (From here)

At face value, this looks a lot like U.S. law on this topic, although I would urge caution in assuming that this is the whole story.

Practical Considerations Depending On The Nature Of A 5-Year Mortgage

This said, the practical reality has a lot to do with the nature of the 5-year mortgage loan. I could imagine three possibilities:

  1. The entire mortgage loan is paid off after 5 years, in which case there is no longer any loan to guarantee and everybody is released at that point.

In this situation, a unilateral release of the guarantor might not be a great concern to the bank if the loan has already been paid for a while, because the house will have much more equity in it, and the loan will have a much smaller balance, after a few years, particularly if the market value of the house is also stable or increasing.

For example, suppose that the house had a fair market value of $100,000 that was increasing at a rate of $1,000 per year, and the original loan amount was $80,000. When the loan was initially taken out, there would be $20,000 of equity in the house, and the lender might feel that it needed a guarantor to be secure.

But, after three years of payments, the house would be worth $103,000 and the loan balance would be about $32,000, leaving about $65,000 of equity in the house, which might be enough that the lender would no longer care about having a guarantee since the roughly 31% loan to value ratio would be so much lower than the 80% loan to value ratio in place initially.

Also, so long as the entire house remained collateral for the loan (i.e., both the 95%-owner's part and the 5%-owner's part), a loss of the ability to sue the 5% owner for a deficiency if the house ended up going for less than the amount of the loan in a foreclosure sale (which is what the loan guarantee would allow the bank to do) would be more or less irrelevant once a lot of the loan was paid down.

The only time an extra loan guarantee would matter in that situation would be in the case of an apocalyptic decline in the fair market value of the home. This could happen due to a Great Depression class housing price bubble collapse, or more likely due to something like the discovery that there was a toxic waste dump under the house, or due to the discovery that the house had defective foundations and was at risk of collapsing as a consequence of bad soils or bad workmanship. Most mortgage lenders are willing to take those kinds of risks.

This kind of discovery happens more often than you would think in states like Colorado and Florida, which have many areas with bad soils and many contractors who fail to hire soils engineers when they should. I probably take on at least 1-2 such cases a year in my very small firm practice, and in Florida where the large law firm where I used to be a lawyer had some offices, we would get half a dozen new cases like that every month. In Germany, undiscovered toxic waste would probably be a more likely problem than a housing bubble or a bad foundation.

  1. The loan is amortized over a much longer time period such as 15 or 30 years (i.e., payments are set so that the entire loan would be paid off after 15 or 30 years of equal monthly payments) at a fixed or limited interest rate, and after 5 years, the loan automatically converts to a variable interest rate loan or limitations on the amount by which an already variable interest rate loan can vary are lifted.

In this case, like the first one, the bank might be willing to release a personal guarantee of a co-owner of the property, so long as the 5% interest of the co-owner in the house continued to be collateral for the loan, since the collateral might be much more important to collection of the debt than the personal guarantee of the guarantor, particularly if the house had a fair amount of equity left in the loan in the first place (and my understanding is the German mortgage lending practice usually involves larger down payments than U.S. mortgage loans do in many cases).

In this case, the interest rate is going up not because the guarantor is released, per se, so much as because the loan can't be refinanced without the guarantor/co-owner's consent which might not be available.

  1. The loan is amortized over a much longer time period such as 15 or 30 years (i.e., payments are set so that the entire loan would be paid off after 15 or 30 years of equal monthly payments), and after 5 years, there is a balloon payment due that must be paid off or refinanced, which if not paid would result in a default and foreclosure of the loan.

If this is the case, the guarantor has immense leverage to force a buyout of her interest, even if she doesn't have a legal right to do so, because otherwise, she can effectively prevent the loan from being refinanced and can force the house into foreclosure if she doesn't co-sign a new loan, since all co-owners need to sign (as a matter of commercial reality) to get any mortgage loan.

On the other hand, in this situation you may actually have an ability to insist that the guarantor cooperate in refinancing the loan (at least by agreeing to allow her 5% interest in the house to be part of the collateral for the loan, even if she refrains, with the bank's permission, from making a personal guarantee of the loan – i.e., her part of the loan would be "non-recourse").

Economically, this would be equivalent to transferring her 5% interest to a limited liability company with no assets other than the 5% interest in the house, and then having you and the limited liability company as co-signers on the new mortgage, rather than having her sign in her individual capacity. But, this probably would result in a higher interest rate at a commercial loan rather than a residential loan interest rate.

The potential duty in this case would arise from the duty of good faith and fair dealing that co-owners of real estate owe to each other, which exists in most U.S. states.

The duty of good faith and fair dealing of co-owners of real property, or something similar, would probably have even more teeth in Germany where this duty is broader and used more widely to discourage conduct that isn't economically fair to one of the parties (although I don't know German law well enough to know just what duties co-owners of real estate owe to each other there, which is likely to differ materially from the majority U.S. rules on the subject).

Types Of German Mortgages

From here. (Note that as used in the quoted material, the term "charges" is better translated as "liens".)

3.1 MORTGAGES AND CHARGES

There are three types of charges.

The ordinary mortgage (Hypothek) depends on the existence of an underlying claim, whereby the Hypothek can only be enforced as long as, for example, a repayment claim for a loan exists. The Hypothek can only be assigned to a third party together with the underlying claim. Nowadays mortgages do not play a significant role in practice as land charges are generally favoured by banks as security for loans financing the acquisition of property.

These land charges (Grundschulden) do not depend on the existence of an underlying claim and can be assigned independently. In almost all cases these land charges will be linked to the underlying claim with a security purpose declaration.

Both the Hypothek and the Grundschuld can be created as a certified mortgage or land charge, i.e. with a document certifying and evidencing the existence of the mortgage or land charge in addition to being registered in the Land Register. Any assignment or variation of a registered certified mortgage or land charge requires the presentation of the original certificate. Certified land charges are sometimes required by financing banks but their use is not widespread due to the formalities required in the event of assignment or variation. From an investor’s point of view, the acceptance of land charges as opposed to mortgages is unavoidable; certified land charges should be and usually are avoided for the reasons mentioned.

In order to be valid, mortgages and land charges must be registered in the Land Register. Creating a mortgage or land charge does not of itself require a notarial deed, however, to enable registration to be effected in the Land Register, notarization is necessary.

The third type of mortgage, which is not commonly used, is an annuity charge (Rentenschuld). This is a form of land charge where the principal amount of the loan is not to be paid out of the land but instalments are to be paid at fixed intervals. Like land charges in general, annuity charges must be registered in the Land Register.

  • 1
    Just to clarify: "In a related post, you mention" - that post ("My co-borrower wants her name removed from a 5 year mortgage contract") is not mine, it just gave me the idea for this question. Most of your (very interesting) answer seems to answer that other post - consider moving your answer there, where it will hopefully even more useful. – sleske Mar 11 '17 at 10:18

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