Has anyone asked you to be their loan guarantor? This decision to become a loan guarantor should be considered carefully and today, we will look into the details that you should be aware of before taking on the responsibility of being someone’s guarantor.
Being a guarantor for someone means agreeing to bear the responsibility of paying off the original borrower’s loan obligations if they default on their loan or are unable to pay. This essentially means that the legal obligation now rests with you.
Since the liability now rests with you, you are obliged to pay off all debts and subsequent charges if payment is delayed. This may open you up to any legal action taken by the lender to claim these debts. Furthermore, you may not be able to recover these borrowed funds from the original borrower.
Why someone would need you to be a loan guarantor
a) Their age is below the minimum age requirement for loan applicants
This is mostly seen in student loans provided by a financial institution/bank. The minimum age for such loans may in some cases by 21 years of age, and as such require a parent or guardian to guarantee their loans. Lenders may also require a guarantor if the loan applicant is near the retirement age of 62-65 years.
b) Lack of assets
For larger loans, lenders often require some form of security that they can use as collateral. However, some borrowers may not have such assets that can cover the value of the loan and would therefore require a guarantor to pledge their own assets as a security.
c) Lack of income
Similar to a lack of assets, lenders may view a lack of income as an inability to make monthly loan repayments. Instead of disqualifying the applicant for a loan, a guarantor may be able to pledge their income as a security in a situation where the borrower defaults on his monthly payments.
d) Poor credit history
Lenders may consider borrowers with poor credit history to be of high risk. Having a guarantor would allow the loan to be processed as it reduces the risk to the lender.
Obligations of a guarantor
Be certain of your obligations as a guarantor, especially with regards to understanding all the details of the loan agreement as if it was a loan that you would take on your own. You have the right to request the lender to provide a full explanation of all details – terms and conditions, clauses and different scenarios.
Some obligations include the following:
a) Principal debtor clauses
This clause passes on the liability of the loan from the borrower to you, the guarantor
b) Payment on demand
The lender may seek repayment from you, and payment will have to made on demand. As a guarantor, you will then be obligated to be responsible for all further charges and interest payments if required. It is important to clarify how these demands will be served to you by the lender, and to immediately discuss what liabilities are outstanding
c) Restructuring
The lender may decide to restructure the loan, however, this does not absolve you from your liabilities
d) Subordination
You may not be able to take action against the borrower until the lender has received all amounts owed first. The lender may deduct funds directly from your account or request payment without providing proof that he has gone to the borrower but was unsuccessful in recovering the amounts owed. You may be restricted from taking security or collateral from the initial borrower that my infringe the rights of the lender. As such, the guarantor can only take action against the borrower once all liabilities with the lender have been cleared.
e) Set Off
The lender may deduct any funds held in a savings account to set off any amount due under the guarantee.
Inability to settle debts
Inability to settle your debts as a guarantor hold the same consequences if you were the borrower. It may affect your credit score which may in turn affect your eligibility for loans in the future, even if the debts are fully paid up.
If you are in default of more than $10,000, you may be subject to bankruptcy proceedings. This may severely limit you from taking on a loan, engaging in certain businesses and facing implications on future career prospects.
Should I even become a guarantor?
If someone approaches you to become their loan guarantor, you will have to ask yourself two important questions:
- Can I afford and am I willing to repay someone’s debt?
- Is the borrower capable of repaying his debt?
Since the consequences of being a guarantor are similar to if you were to take the debt on yourself. You should also have an in-depth understanding of the loan and the borrower’s capacity to service the loan.
– Request that the borrower provides you his loan documentation and credit report so that you understand his ability to service the loan
– Question the borrower of his reasons for going into debt, and how he plans to budget for repayment of this loan
– Discuss any other outstanding financial obligations that the borrower has
– Check if the loan is secured loan, and what has been collateralised – the more securities offered for the loan, the lower the risk of default, thereby limiting your exposure
– If the borrower takes this loan for a business, work out a repayment plan. Assess the ability of the business in providing a stable regular income
– In the worst-case scenario, can you afford to lose more money without certainty of being repaid?
Assessing your liability
It is important to know when your role as a guarantor becomes “active”. The lender may request that you repay the debt the moment the borrower fails to service the loan. Do clarify details. Such as the circumstances under which the lender extends their request to you for debt repayment. Also, how much you will be liable for in that scenario. Also determine if your liability is capped at a specific amount or if it is unlimited. Do ask when your liability as a guarantor will be relieved. In addition, ask the lender how he/she plans on notifying you regarding any updates.
Once again, we iterate that being a guarantor is a large personal responsibility. One should not be ashamed when asking family/friends difficult questions before committing to this responsibility. Especially if you are not in a financial position to provide such assistance.
