Loan Guarantor: Meaning and Risk to Guarantor

A loan guarantor is an individual who assures that a borrower’s loan will be repaid, with the guarantor risking their assets to cover the loan if necessary.

By Brad Nakase, Attorney

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Loan Guarantor Meaning

Being a loan guarantor means accepting financial responsibility for the debt if the primary borrower defaults, requiring you to repay the outstanding loan amount. A loan guarantor is a person who agrees to take responsibility for a borrower’s loan if the borrower defaults on the loan. The loan guarantor gives a guarantee to the lender that the unsecured loan will be repaid. The loan guarantor’s responsibility is to ensure that the lender receives payment if the primary borrower fails to repay the loan.

Guarantors must meet the following requirements:

  • Have good credit
  • Financial stability
  • Be at least 21 years old

This individual essentially agrees to take responsibility if the borrower does not pay back the loan. Thus, the lender will not charge higher rates to make up for the borrower’s high risk. A guarantor can also assist an individual who does not have much income, few assets, or is otherwise in financial need. Credit history is an important factor when it comes to getting an unsecured loan, but salary and assets are also considered. If you have questions concerning a business loan dispute, please contact our San Diego commercial litigation attorney.

What Is an Unsecured Loan?

For a business owner who has not built up a good credit history, it can be difficult to find good financing options. Unsecured guarantor loans offer a way for borrowers with poor or limited credit histories to get financing for their business. That said, to qualify, a business owner will need to identify a guarantor who will back the loan. This article will explain what an unsecured loan is, as well as the role of a guarantor.

Every loan, whether it is a business loan or a personal loan, is categorized either as secured or unsecured. A secured loan means that the lender requires collateral, which can be anything with value, such as:

  • Property
  • Vehicles
  • Equipment

With a secured loan, a lender can seize the offered collateral if the borrower cannot make the required payments in time or in full.

If a business owner takes out an unsecured loan, however, then the business lender cannot take their assets. That said, the lender can still submit the account to collection and sue the business owner to get their money back. Because there is no collateral to “secure” an unsecured loan, the lender is taking on more risk. They can only rely on the business owner’s credit history. Thus, unsecured loans are generally more expensive. Also, because unsecured loans will take a business owner’s credit history into account, lenders are less likely to approve a business owner with a bad credit score.

As a loan guarantor for an unsecured loan, the guarantor is responsible for repaying the debt if the primary borrower defaults. Without collateral securing the loan, the loan guarantor’s assets or creditworthiness serve as a form of security for the loan, obligating the loan guarantor to cover the outstanding balance, including interest and fees, in the event of non-payment by the borrower. The loan guarantor’s obligation extends to the entire loan amount.

How Do Guarantor Loans Work?

Guarantor loans involve a third party, the guarantor, who contractually promises the lender that if the primary borrower defaults on the loan, the guarantor will cover the loan payments. The loan guarantor typically needs a good credit score and stable financial standing to support the loan.

Basically, an unsecured loan is a kind of loan that:

  • Is not secured by collateral
  • Has been guaranteed by an individual with financial stability

Any loan that has the above qualities may be called an unsecured guarantor loan. However, one’s options may still vary. For instance, not all guarantees are equal. One individual may offer to guarantee an entire loan, while another may only offer to guarantee a part of the loan. Going after a partially guaranteed unsecured guarantor loan is riskier than if the loan is fully guaranteed.

Because of this, a partially guaranteed loan is generally more expensive because the lender needs to take into account the additional risk.

It should be noted that simply having a co-signer does not make a loan guaranteed. Co-signers have different financial obligations and rights than guarantors. For instance, a guarantor is only financially responsible if the lender has looked into all collection methods first. By contrast, a co-signer is considered as a second borrower if the loan is not repaid. Also, if the loan is secured by collateral, it is considered to be a secured guarantor loan.

What Are the Advantages of an Unsecured Guarantor Loan?

  1. Less Strict Requirements

Assuming a business owner has a guarantor with a good credit score, the lender will not judge the owner’s credit score too harshly.

  1. Competitive Pricing

As discussed, a guaranteed loan reduces risk for the lender. As a result, the overall cost of the loan will decrease. In comparison to other funding options for borrowers with poor credit, unsecured guarantor loans are well-priced.

  1. Larger Loan Amounts

Because this type of loan is generally lower risk, it can help borrowers get larger loan amounts. Also, the interest rates are typically lower than other kinds of funding.

  1. Collateral Not Necessary

Rather than making collateral a requirement, the lender uses the guarantor’s credit score as evidence that the loa will be paid back. If a business owner does not have assets or does not want to risk losing them, then it may be worthwhile finding a guarantor.

What Are the Disadvantages of Unsecured Guarantor Loans?

  1. Potential Damaged Relationship with Guarantor

A business owner’s financial fate is connected with that of the guarantor. This means if the business owner fails to pay off the loan, there can be problems with his or her relationship with the guarantor. Before agreeing to be a guarantor, it’s essential to assess the borrower’s ability to repay the loan and understand the potential financial risks involved. Acting as a guarantor can affect relationships, especially if the borrower defaults and the guarantor must cover the debt, potentially leading to strained relationships.

  1. Risks to the Guarantor

Being a loan guarantor means that the guarantor’s credit history and financial stability are crucial, as any missed payments or defaults by the borrower can impact the guarantor’s credit score and financial standing. If the borrower does not repay the loan, the guarantor must cover the difference. The default will not only hurt the business owner’s credit score but also show up on the guarantor’s credit report. Also, being a loan guarantor means that the guarantor’s borrowing capacity is diminished because the guarantor may not have sufficient assets to cover all the outstanding loans.

  1. The Loan Guarantor Must Share Private Financial Information

A loan guarantor has to share private financial information, such as their bank account and other financial details. Becoming a loan guarantor means that the guarantor has to sign loan contract, and financial disclosure.

  1. High Interest Rates

This type of loan can be cheaper than other financing options for business owners with poor credit. That said, it may not be more affordable than traditional funding options, such as a secured business loan.

What Are Funding Alternatives?

This type of loan is best for individuals with low credit scores. If a business owner is interested in this type of loan, then they should be aware that alternative options must be lenient when it comes to credit score as well. Financing alternatives include the following:

  • Invoice factoring
  • Merchant cash advance
  • Equipment financing
  • Credit cards

Conclusion

Financially speaking, unsecured guarantor loans make sense for those whose credit is poor. However, if a business owner is unable to repay his or her loan, then the guarantor is held responsible, which could damage the relationship. That does not mean it is not a risk worth taking; both parties must simply be aware of the risks before signing any loan agreement.

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