A guarantor on a loan is someone who guarantees repayment on a loan if it cannot be repaid. In most cases, the guarantor is a third party aside from the primary borrower, who helps them access funds even with limited credit history and insufficient income. Usually, this person is a family member or close friend. Keep reading to learn more about the role of a guarantor, the different scenarios you might find a guarantor in, and some of the risks involved with taking on that role.
The Primary Responsibility That a Guarantor Signs Up for
As mentioned above, the primary responsibility that a guarantor will have, is to pay back a loan if the primary borrower or entity cannot. This balance includes the entire outstanding loan balance, including any fees incurred during the process. If the guarantor has to pay back the debt, most lenders will work with them to come up with some kind of repayment plan. They may also be open to negotiation for a settlement; it all depends on the lender and loan type.
Requirements To Be a Loan Guarantor?
Because a guarantor is essentially financial security for a lender, there are some requirements they must meet. To be a guarantor, a person must have good credit history and enough income to be able to repay the loan amount being borrowed. Lenders will take a good look at the guarantor’s credit history to determine whether they want to lend money to the primary person/business applying for the funding.
What Scenarios Would Involve a Guarantor?
There are a few scenarios where you will see a guarantor loan agreement:
A Loan With a Cosigner
A person with poor credit history can add a cosigner to a loan. A cosigner is a guarantor of a debt that accepts to take on repayment for the entire loan amount if the primary borrower cannot pay. If the primary borrower does make their payments, the cosigner doesn’t have to take any other active part with the loan. Personal loans, credit cards, online payday loans, auto loans, and mortgage loans can all have a cosigner.
A Loan With a Co-applicant
Another scenario in which a guarantor will be a part of the loan process will be with a joint loan, where there is a co-applicant/co-borrower. A co-applicant can be added to a loan if one person has a low credit score, does not meet the minimum income requirements, or if more than one person wants to co-own an asset. In this scenario, each person is a loan guarantor if the other cannot pay it back. A co-applicant loan can also be called a joint loan. You will often see joint loans—where both parties are equally responsible—with mortgages and car loans.
A Business Loan in Some Situations
A guarantor may also be a part of a business loan. If a business owner has their business model set up as a sole proprietorship or partnership, their personal credit will be linked to their business. And so, if they take out a business loan, personal credit will be looked at. On the other hand, LLCs and corporations will have separate credit scores that lenders will look for business loan approval. If the business is relatively new, they may ask the owner to be the loan’s guarantor for security in case the company doesn’t do well enough to repay the loan.
Risks of Becoming a Guarantor?
If you are thinking about becoming a guarantor or have a prospective guarantor in mind, you should be aware of the different risks that come with the role. Here are some scenarios that can happen:
If the Primary Borrower Defaults, the Guarantor Will Have To Pay the Loan
When a person is signing up to be a guarantor, they are agreeing to be legally responsible for the loan if the other party involved with the loan process cannot repay it. And so, it is crucial that the guarantor takes that responsibility into consideration. As loan default could mean hundreds or thousands of dollars of debt to repay, funds that the guarantor may have not even used!
The Role Can Impact the Guarantor’s Credit Record
Another thing to remember is that a guarantor’s credit score will be impacted when signing up for the role. Here are a few different ways that a guarantor’s credit score may be affected:
Credit Utilization Ratio
A credit utilization ratio is a ratio between a person’s debt and available credit. When a person signs up as a guarantor, their credit record will have the new loan. This means that their credit utilization rate will increase. Anything over 30% can harm credit, so keeping track of this ratio is essential before agreeing to sign up as a guarantor.
Lenders will conduct a credit check on a guarantor to see whether they have a good credit score and better understand their financial situation. A single credit check will bring down a credit score by around one to five points. Having multiple in a short time can have a meaningful impact on all three credit scores. And so, it is imperative to keep that in mind before signing up a guarantor on multiple loan applications with different lenders.
This is one of the most impactful parts of being a guarantor. How the primary borrower makes their monthly payments will have a massive impact on the guarantor’s credit! One late payment can mean an adversely affected score, while on-time monthly payments can help.
Loan Default and Collection Accounts
If the primary borrower/entity cannot repay the loan on the agreed-upon amount, the loan will default. The actions leading to default will significantly negatively impact the guarantor’s credit score! If the lender decides to use a debt collector, that can be even more devastating to your finances. A collection account will remain on a credit report for up to seven years and can look bad to potential lenders.
Can Harm Personal Relationships
As mentioned above, most of the time, guarantors are close friends or family members. If things go unexpectedly wrong with repayment for a loan, it can hurt the relationship.
How To Protect Yourself as a Guarantor?
The last thing you want to do as a guarantor is to walk into a loan contract with a strong credit score and leave with your own finances being turned upside down. And so, to protect yourself with this role, it can be helpful to do some financial planning of sorts before deciding to sign up as a guarantor. Here are some ways to protect yourself:
Ensure You Have Enough Funds To Pay the Loan Payments on Your Own
Because you may have to end up paying back a loan that you are a guarantor on, it will be a good idea to make sure that you can repay the loan if you have to. Make sure that the monthly payments would be manageable or that you can pay all of it in a lump sum if needed.
Get Specifics From the Person You Are Cosigning or Co-Borrowing With
Another thing you should do to protect yourself as a guarantor is to get specifics from the person you are trying to help out. Ask about their financial situation and get proof if necessary. Although this may be a little awkward, you’ll want to make sure they can repay the loan so you don’t have to worry about taking care of it yourself. In most cases, you may already know the borrower’s finances.
Carefully Go Over the Loan Terms Before Signing Anything
The loan application will have all the details you need to know about a loan. And before signing to be a part of it, you should carefully review things. Make sure you know the loan amount, interest rates, repayment terms, and general rules of the loan contract.
Keep Track of Loan Payments
As a guarantor, a loan will impact you until it is completely paid off. And so, to ensure that you know what is going on, you must keep updated about your loan payments. In most cases, the guarantor will know if there are any late or missed payments. Still, it doesn’t hurt to have additional information about things like due dates so you can confirm the payment with the primary borrower when getting close to that monthly deadline.
Key Takeaways With the Role of a Guarantor
Guarantors can be part of a loan or credit application for a borrower or entity with a less-than-perfect credit score or insufficient income requirements. With a guarantor, a lender gets security that another person is willing to be responsible if the primary borrower falls through. And so, they may be more inclined to work with a borrower with an atypical financial situation. You can find guarantors with a cosigned loan, joint loan, and some business loans. Before taking on this role yourself or asking someone else to do it for you, it is extremely important to know the risks that come with it.