Probably the most common situation where someone guarantees a loan taken by another person is that of parents doing so for adult children who wish to buy a house.
In other situations, a person may be a guarantor for a business loan taken out by someone else.
In either situation being a guarantor for the loan – meaning you become legally responsible to the lender that you will pay back the loan if the person the money is lent to fails to make repayments – is an admirable thing to do, but also carries some pronounced risks.
Let’s take a more detailed look at some of the pros and cons of being a guarantor below. Before you agree to be a guarantor, however, or ask someone else to go guarantor on your loan, seeking professional advice from legal specialists with expertise in the rights and responsibilities of this role is essential.
What are the risks of going guarantor on a loan?
Before you agree to be a guarantor on a loan, you should ask yourself some searching questions. Becoming legally liable for someone else’s debt is a considerable burden, and could severely impact your own lifestyle and future.
Particularly in family situations, where a parent may take on the guarantor role to help an adult child take out their first home loan, emotion can sometimes cloud reason.
The key risks to be aware of are:
- Being liable for the entire loan, plus interest and fees, if the borrower can’t make the repayments and defaults. If you are also unable to meet the terms of the loan, the lender may proceed to repossess the asset/s you nominated as security for the loan, including your house.
- As a guarantor, your own ability to apply for a loan may be affected. You will be required to inform a lender of any other loans on which you are a guarantor.
- Should you as guarantor, or the borrower, be unable to meet the terms of the loan, your credit report will be adversely affected and your ability to borrow in the future may be impaired.
A guarantor also needs to consider the possible effect of a family member defaulting on a loan for which they are guarantor. The relationship may be irretrievably broken if the trust implicit in the arrangement is breached.
Guarantor on business loans
Whereas a family member will generally be the guarantor on a home or personal loan, partners, investors or associates are also commonly guarantors when someone applies for a business loan.
With this type of loan, the lender will generally need to be convinced that the guarantor has a genuine relationship with the borrower, an interest in the business and sufficient assets to guarantee the loan.
A residential or a commercial property would usually be considered a sufficient asset to be offered as security for the loan.
Where the loan is for a new business, the guarantor will generally be guaranteeing 100 per cent of the loan because the new business has no assets to use as security. If the loan is to purchase commercial property, the guarantor will usually guarantee a 30 or 40 percent portion of the loan.
Important final questions
As we mentioned earlier, a potential guarantor needs to ask some important questions before signing on to guarantee a loan.
Does your financial situation allow you to take the risk of losing the asset you have offered as security? Are there are other ways you could help achieve the aim of the borrower, such as loaning the money to them directly? How strongly do you trust the borrower to make the necessary repayments?
It’s crucial that before agreeing to be a guarantor, you examine the loan contract, business plan or any other relevant documentation the borrower needs to provide to the lender. The best advice is to treat the loan you’re guaranteeing as if it were your own.
The process can be time-consuming and involved. Expert legal advice from experienced advisers such as Felicio Law Firm is essential. Whether it’s a home or business loan you’ve been asked to guarantee, we can provide understanding and relevant guidance on how to approach the question.