In the years since the start of the global financial crisis, there has been rapid growth in a whole range of personal loans that we might refer to as alternative loans. These are loans that are not obtained through the traditional sources of mainstream banks or other lending institutions such as building societies but more typically through loan brokers and niche lenders. There are many reasons why people are increasingly choosing to avoid the more conventional sources of lending and are seeking out these alternative types of borrowing.
One reason is simply lack of availability – banks have implemented increasingly strict lending criteria so if you don’t have a whiter than white credit history you may be unable to secure a bank loan at all, or will only be able to secure one at a high rate of interest.
The other factor driving more and more people to seek alternative loans is the cost. If your credit score is not perfect then the bank or other lending institution may agree to a loan but only at a significantly higher rate of interest than their headline rates. As such their interest rates may be prohibitive over the life of the loan to some borrowers.
Another reason people seek alternative loans is that they often only need the money in the short term and don’t want to commit to the type of long term loans that banks specialise in. Interest rates may be lower with conventional lenders but if the loan term is longer the overall cost to the borrower will be higher.
So just what are these types of alternative loans, what can they be used for and what are their advantages and disadvantages? The commonest types are guarantor loans, payday loans, instalment loans and doorstep loans. Here we are going to take an in-depth look at guarantor loans and consider both the pros and cons of guarantor loans for both individuals and for small businesses. This guide is designed to describe how guarantor loans work, the risks and responsibilities of this type of borrowing and to help you decide whether they could be right for you as a borrower and also as a guarantor.
Why Are Guarantor Loans Needed?
Most people’s first port of call when looking for a loan would traditionally have been their bank or building society but that all changed with the global financial crisis and ensuing credit crunch that started in 2007 and led to a severe shortage of credit. This resulted in the major lending institutions implementing much tighter controls on lending and stringent affordability checks that meant many people could no longer obtain a bank loan. This included people with a poor credit history but also young people with no credit history, who became locked on a Catch-22 situation where they could not obtain credit because they had no credit history but could not build up a credit history because they couldn’t get credit.
This credit crunch situation led to non-conventional lenders offering alternative loans such as guarantor loans.
What Is a Guarantor?
Every guarantor loan requires a guarantor who is someone other than the person taking out the loan but who is jointly responsible for the loan agreement. The guarantor formally agrees to make the loan repayments if the borrower is unable to do so. Clearly, then, there is a risk to the guarantor that this situation might arise and they will have to come up with the cash to make one or more of the loan payments.
Guarantors are often parents, grandparents or other family members who want to help out younger relatives – it could be help raising the deposit on their first home, or help to consolidate expensive credit card and store card debts into a single, more manageable loan, or it could be to buy a new car or complete a training course that will help them on the next step of their career. There are many reasons why young people may need such help and the fact they cannot obtain a loan themselves does not mean that they are not financially responsible or able to pay back the loan.
For those who run small businesses, guarantor loans can also be a way to raise cash in the medium term to alleviate cash flow problems or to fund growth. In business situations, the guarantor can sometimes be an angel investor rather than a family member.
The reason that lenders offer guarantor loans is that the guarantor will be required to have a good credit history (better than the borrower’s) so the risk to the lender is less than if they lent directly to the borrower alone without the security of a payment guarantee in place. From the lenders perspective, they are essentially lending to someone with a good credit record.
What Are The Responsibilities of a Guarantor?
Being the Guarantor on a loan is a serious responsibility because it could affect your own finances, credit history and ultimately your lifestyle if something unexpected goes wrong and the borrower cannot meet their loan payment commitments. It could also affect your personal relationship with the person who took out the loan, which is a concern if the borrower is a close relative. If the borrower to whom you are acting as guarantor cannot make one or more loan repayments for whatever reason, then the guarantor is legally responsible for repayments and, in extreme circumstances, may have to repay the whole loan.
Obviously, as a guarantor, you would not enter into such an agreement if you did not have confidence that the borrower could keep up with the loan repayments, but sometimes unexpected things do happen in life. The borrower could lose their job, for instance, and struggle to find another one so a guarantor should always consider the worst-case scenario and assess whether they could, and would want to, cover the debt themselves.
If, as a potential guarantor, you have any doubts about making the loan repayments then consider more fully whether guaranteeing a loan is the right thing for you to do. Ask yourself the following 4 questions to help make a final decision:
- Does the borrower genuinely need the loan for a good reason?
- Do you think the borrower can easily keep up with the loan repayments, even if additional, unexpected costs were to arise?
- If you had to make the loan repayments how would that affect your own finances, you’re your own lifestyle and personal circumstances? Could that result in hardship for you?
- Do you trust the borrower? If you have to step in and make repayments how will your relationship be affected?
What Are The Responsibilities of the Borrower?
A guarantor loan can seem like a perfect solution that could help you in any number of ways. Imagine the scenario – you have applied for a loan but the lender wants a guarantor – your parents are willing and able to act as the guarantor and that means you can finalise the loan and will get a much more affordable rate of interest – so what could be simpler? After all, you will be making the repayments. However, before entering into such a loan think very carefully about what could happen if you are unable to make the repayments – through no fault of your own, you might lose your job or become too ill to work. And think carefully about whether you really can make the payments if you have unexpected costs like your car breaking down or your boiler packing up. What would be the impact of such an event on your guarantor, particularly if they have debts of their own such as a mortgage or a car loan?
As the main borrower, you have a responsibility to carefully consider the risks of taking out such a loan – risks to you and your guarantor and your future relationship with the guarantor. These loans have legally binding agreements so should be taken very seriously.
What If The Borrower Misses a Loan Payment?
Most reputable guarantor loan companies will initially talk to the borrower if a loan repayment is missed to determine whether there are any serious ongoing concerns and difficulties making the regular payments. Where possible they will work with the borrower to resolve the issues otherwise the lender will go on to contact the guarantor to recover the missed payment(s) and the guarantor is then legally bound to make all the remaining repayments to the end of the loan term.
What Are The Downsides of Becoming a Guarantor?
When you become a guarantor you take on the legal responsibility to make the loan repayments if the borrower cannot so there is an impact on the guarantor’s ability to borrow on their own behalf should they need to. You might consider that lending to a family member is a kind or even dutiful thing to do, but remember that banks and other lenders will view the guarantor loan as a financial commitment influencing your ability to borrow money on your own behalf. So think carefully about whether you might need to borrow money yourself during the term of the loan because you may find you cannot, or that you cannot borrow as much as you would like.
How Do Guarantor Loans Work?
A personal loan with a guarantor involves two people signing the loan agreement, as well as the lender: the borrower and their guarantor. The guarantor will typically have a good credit score so their inclusion on a joint agreement means the loan amount will be approved when it would not be for the borrower alone because the lender views this as a less risky proposition.
Once the loan is agreed the borrower starts to make the regular monthly payments – sometimes, depending on the particular lender, the guarantor is required to set up a direct debit that will be used should the borrower fail to make a payment in time. In the ideal situation the guarantor need never become involved, however, if the borrower fails to make the repayments for whatever reason then the guarantor will become legally obliged to do so.
How Much Can You Borrow on a Guarantor Loan?
Guarantor loan amounts vary from lender to lender and, of course, depend on how much the borrower can afford to repay, but are usually anything from £1,000 to £15,000 and can be repaid over any period up to 5 years. As one of the leading no-fee guarantor loan brokers, we can quickly tell you which lenders will lend to you in principle – typically our applicants receive 4 loan offers in principle. Apply here.
A Final Word About Borrowing Money
So you now have a clearer idea of what a guarantor loan is and the advantages and disadvantages of this type of borrowing. But before you go ahead and borrow money with any type of loan ask yourself the following questions to decide whether you really need that extra money:
- Is the borrowing required for something important such as a deposit for a home or a car to get you to your place of work? Or is it simply to improve your lifestyle such as a holiday or home improvements?
- Can you comfortably manage the repayments along with your existing expenses?
- Could you still make the repayment if an unexpected cost arose such as a washing machine breakdown?
Could you defer taking out a loan and work on improving your credit score to help you obtain cheaper borrowing in the future?
- Kickstart your business with a guarantor loan
- How Guarantor Loans have changed and why you could consider one
- Can a guarantor loan affect the guarantor’s credit rating?
Amanda Gillam is Solution Loans's General Manager and has been since 2009. She is also a prolific writer on personal finance issues, and has been quoted numerous times in articles published on 3rd party websites and in press releases. Her...Read more about Amanda Gillam
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