A guarantor is a term in finance to describe an individual who agrees to pay a borrower’s debt should the borrower default on their loan obligation. The guarantor will pledge their own assets as collateral against the loan and is often needed when a borrower has a poor credit history or a poor credit score.
How a guarantor works
Typically, a guarantor has to be over the age of 18 and must live in the country where the payment agreement exists. Guarantors usually have excellent credit histories and scores and have the income or assets to cover payments should the borrower default on payments.
In addition to covering the loan payments, a guarantor can also be liable to pay interest owed or penalty fees and can also be used to secure a rental agreement on a property.
If a guarantor has pledged assets to cover the repayment, their assets can be seized if the borrower fails to repay the loan. Unlike a co-signer, a guarantor has no claim to the asset or assets purchased by the borrower using the loan.
For example, a borrower takes out a loan to invest in new computers for their business but needs a guarantor to secure the loan. 6 months into the loan agreement the borrower is unable to make payments, so the guarantor becomes responsible for the loan, any interest owed and penalty fees, but cannot take the computers to recoup their costs. The computers are still the property of the borrower.
Types of guarantor
A guarantor may be requested in a variety of scenarios from not having a high enough income to having a poor credit history. Also, there are different levels of guarantor’s, they don’t always have to be liable for the total monetary obligation in the guarantee.
The different types of guarantors include:
Guarantors as certifiers
As well as pledging their assets as collateral, these types of guarantors may help individuals secure jobs and passport documents. For this purpose, guarantors certify they personally know the applicant and can confirm their identities.
Limited guarantor
A limited guarantor may be asked to guarantee a loan up to a specific point in time. After which the responsibility of repayments and consequences of defaulting fall solely on the borrow. Limited guarantors can also only be responsible for a percentage of the loan, this is known as a penal sum.
Unlimited guarantor
Unlike a limited guarantor, unlimited guarantors are liable for the full amount of the loan for the full duration of the loan agreement.
What are the benefits?
Enables borrowing
Borrowers who are unable to borrow the amount they need or get any loan can access a range of lending options with the use of a guarantor. In turn, the loan can be used to further help the borrower expand their business or rent new premises. Using guarantors can be a good way to keep economic activities moving.
Can improve credit history
If a borrower can take out a loan using a guarantor but repays the loan without having to use the guarantor this can help improve their credit history as they have demonstrated that they have fulfilled the terms of the loan.
Gives lenders security
Lenders often refuse loans to individuals with poor credit histories or insufficient incomes, but using a guarantor gives them the security that even if the borrower defaults on the loan, they will still get their money back via the guarantor.
What are the drawbacks?
Guarantor may have limited borrowing options
If an individual is acting as a guarantor for someone else it may impact how much they are able to borrow themselves. Even though it is not a given that they will have to step in and cover the costs of the loan, lenders will still factor this into their lending decision to ensure responsible lending.
Could impact guarantor’s credit score
If a guarantor has to cover the costs of a loan on behalf of the borrower they are acting as a guarantor for, it can negatively impact their own credit score. Which may affect their borrowing power in the future.