If a family member or loved one has asked you to be guarantor of their loan, don’t blindly agree to it because of the trust you have for that person. It’s important to know exactly what you would be getting yourself into. That’s why we’ve detailed out exactly what could happen if you become a guarantor or someone else’s loan.
What is a guarantor of a loan?
Being a guarantor involves being liable for your loved one’s loan should they no longer be able to make their payments. In essence, if they can no longer pay, you will have to do so in their stead. Needless to say, being a guarantor is a huge commitment that requires a lot of trust. If the person you are a guarantor for can no longer pay, lenders will contact you. And if you cannot pay their debts, then lenders may go through a debt collection process with you. This means that collections agencies could start contacting you and court action could potentially be taken against you.
Why are guarantors needed?
There are many reasons as to why banks might ask for a loan guarantor. Some of the most common reasons are:
If a person with very little credit history is asking for a loan
Banks don’t know if that person is reliable because they’ve never had to deal with loans/credit before. These are usually young adults or people who have just moved from another country.
If a person’s salary is too low
If the person asking for the loan has a salary that is too low or whose salary comes from unconventional sources (dividend stocks, rental properties, etc.), then lenders will likely ask for a guarantor. This is because salary received could vary, so it isn’t completely reliable. The same could be said for someone starting a new job. Moreover, if the salary is too low, then there’s no guarantee that the borrower will be able to pay it back.
If a person’s credit score is too low
Understandably, if a person’s credit score is too low, lenders will ask for a guarantor. Having too many loans as well as one’s ability to pay back a loan on time are factors that heavily affect credit scores. So if a person’s score is too low, lenders will be wary.
A person might ask you to be their guarantor is they need a loan to buy a new car, a new house, or starting a new business. Regardless of the reason, both parties need to think about the possible repercussions. The person asking for the loan needs to be 100% certain that they really need it — and they need to be 100% certain that they can pay it back. On the other hand, you need to think about the relationship you have with that person and whether their inability to pay it off will affect it. You should also ask yourself whether you’d be able to handle their debt should they default.
Will your credit score be affected?
If you agree to guarantee your loved one’s loan, then it is as if you are taking on another debt. Of course, if the original borrower fails to pay, it will affect your credit score. Similar to a joint debt, if one party fails to make the payments, the responsibility will fall on the other party. Although being a guarantor won’t show up on your credit report as long as the original borrower keeps making their payments, lenders will run a credit check on you, too. This credit check will appear on your credit report and may temporarily affect your credit score. Moreover, if the original lender “defaults” (does not pay make the loan), then the loan will be added to your credit report with the word “default” — which implies that the debt is overdue. The lender could even take legal action against you if you fail to repay the amount owed. That’s why, before agreeing to be guarantor of a loan, you should follow certain steps in order to protect yourself.
How can you protect yourself?
There are a few things you can do before agreeing to be a guarantor:
Have a sit-down with the person asking you to sign
Usually, a person who will ask you to guarantee their loan is a person that is close to you. If that’s the case, then there’s no shame in asking them if you can review their financial situation together. It’s always best to come up with a plan for the worst-case scenario. Oftentimes, the original borrower will review their budget and find that they won’t even need to ask for a loan in the first place! Or, they might find that if they save money for a while, they can apply for a smaller loan without needed a guarantor. In order to come up with the right plan of action, review that person’s budget, or create a new one to help them through their situation.
Ask them for a copy of all of the documents
If you agree to go ahead with guaranteeing your loved one’s loan, then you should ask for a copy of your loved one’s credit agreement so that you can keep track of the payment schedule. You should also read all of the conditions of the guarantee before signing. In some cases, you can even ask the lender to be a guarantor for only a portion of the loan, so that you don’t have to commit to paying off the entire thing should the original borrower default.
Don’t be afraid to say “no”
If this person asking you to be guarantor of their loan really cares about you, then they won’t put you in a position in which saying “no” will ruin your relationship. Remember that you should always protect yourself first. If you do happen to say no, and the borrower has no other option, refer them to a licensed insolvency trustee. If the borrower can’t get a loan because they already have debts, a licensed insolvency trustee (LIT) will help them rebuild their credit and get rid of their debts so that they can have a healthy financial future.