For someone without a great credit score, finding a friend or relative willing to be a guarantor can be a simple solution to getting rejected for credit. If you’re willing to stand as a guarantor for someone you know then you’re doing them a great favour. However, it’s also important to understand what you’re signing on for and what might happen if they’re not able to pay back the loan.
What is a guarantor?
If you decide to be a guarantor then you’re guaranteeing the obligations of the person who is taking out the loan. In practice, that means that if the borrower can’t make any repayments on the loan you’ve agreed that the lender can demand them from you instead. Guarantors are asked to sign a guarantee agreement – this is a legally binding document and once you sign it you become responsible for the loan repayments if the person you are acting as guarantor for cannot pay.
Why do lenders ask for guarantors?
It all comes down to how creditworthy the borrower is. If there is any reason to doubt that they might be able to repay the loan – for example, they have a poor credit score – the lender will look for back up in case there is a default. The guarantor is the back up that enables the lender to advance the loan without taking all the risk on to their own shoulders – hence the term “guarantor loan“.
What happens if the borrower doesn’t repay?
The lender can come directly to you, the guarantor. If the lender decides that it will be simpler and less costly to pursue you for what is owed, as opposed to the borrower, then you will be the first port of call after a payment default. You will then be obliged to make the payment that the lender is requesting, in line with the guarantee agreement signed.
What are the risks in being a guarantor?
- You will be required to make payments due under someone else’s debt – the total amount could be more than the original loan with default fees and interest
- You don’t have any right to the amount borrowed by the person you are guaranteeing but the guarantee agreement makes you responsible for repaying it
- If you aren’t able to make the necessary payments the lender can pursue you for it, via the courts if necessary
- If you get into trouble financially as a result of repaying someone else’s debt as a guarantor then this could affect your credit score
- If you have been asked to provide security for the loan then you risk losing this if you can’t make the repayments (e.g. your car)
- If you end up out of pocket it could affect a close relationship
What does the lender need to do?
Lenders must be responsible and take steps to ensure that you would be able to make the payments you’re agreeing to as guarantor should that situation arise. Most lenders will recommend that you take independent legal advice so that you know what’s involved. If you don’t, lenders must communicate to you key information, such as what your liability will be, the fact that it can be limited, whether you’ll be told if the borrower gets into difficulties and what clauses in the credit agreement affect you (e.g. interest).
How can you protect yourself?
As a guarantor there are a number of ways to protect yourself, from the debt and also from making a poor decision.
Before you sign anything:
- Avoid “All Obligations” guarantees – if your guarantee uses this language then you are guaranteeing not just this loan but any others that the borrower has too
- Get the guarantee in writing – it should state the amount of guarantee, how long it lasts for and when your obligations might kick in
- Choose security carefully – the lender will likely ask for security for the guarantee. This should not be something that is worth more than the debt or anything you can’t afford to lose
- Think about the borrower – is this someone who is responsible enough to manage their own debt? Do they really need this money?
- Create a written agreement with the borrower that covers who is responsible for which part of the loan. You can also include clauses that allow you to see what is in the borrower’s accounts and to insist the borrower keeps you informed of their financial decisions
- Think about whether your finances are in a good place – can you actually afford to repay this loan if asked to?
Once the guarantee is signed:
- If you’re not happy then cancel the guarantee. This can be done at any time. You will still be responsible for the original loan until it is repaid but not for any further debt of the borrower’s
- If you were forced to sign the guarantee under undue influence or you feel the credit agreement is oppressive then you may be able to challenge the lender’s right to come after you
- The definitive guide to guarantor loans
- Been asked to be a guarantor? Here’s what you need to know
- Kickstart your business with a guarantor loan