A personal guarantee involves a person or entity agreeing to pay an obligation, such as a loan, if the original borrower responsible for the obligation fails to pay. What happens when the original borrower fails to pay, and the guarantor also does not pay? The creditor or collection agency can pursue the guarantor in the same ways that it could have pursued the original borrower, even seizing their property or garnishing their wages in some cases. This does not totally remove liability from the original borrower, though. They may also face collection efforts from the creditor or a collection agency, and the guarantor may pursue them for reimbursement if the guarantor pays off the loan.
If the original borrower files for bankruptcy, they should be able to get their debt on the loan discharged. They also should be able to discharge any obligation to reimburse the guarantor for payments made on the borrower’s debt.
Types of Guarantors
Generally, a personal guarantor for a loan will be someone who knows the borrower closely, such as a family member or a friend. But there are also situations in which an entity such as the state or federal government may serve as a guarantor. This allows the government to take control of the loan if you fail to make payments on it. You would need to pay off the loan to the government or negotiate a repayment plan with it. Sometimes a lender will want to have an individual guarantor even if the government serves as a guarantor.
If you are taking out a loan as a small business, the lender may be concerned about getting paid back if the business fails, which happens relatively often. They may require someone to serve as a personal guarantor, and they probably will verify that the guarantor will be able to pay off the loan if needed. The guarantor usually is an owner or manager of the business. Loans that are guaranteed by the Small Business Administration require that any person who has an ownership interest of 20 percent or more in the business serve as a personal guarantor.
Drawbacks of Offering a Personal Guarantee
A personal guarantee is helpful to the original borrower in the loan because it may compensate for any credit problems that they have, reduce the interest rate on the loan, and increase the amount that they can borrow. However, you may want to think twice before agreeing to serve as a guarantor if you are at all uncertain about the borrower’s ability to pay. (Usually a lender has a reason to ask for a guarantee, and the borrower may be less financially secure than you think.)
Problems associated with the loan could appear on your credit report and undermine your credit score. Also, if you are guaranteeing a loan for a family member, you may not want the financial pressure arising from the loan to undermine your relationship with them. You should not agree to guarantee a loan unless you are confident that you will have the resources to pay the entire amount if needed.
If the worst-case scenario occurs, and you cannot pay back a loan for which you are a guarantor, you can get this type of debt discharged through bankruptcy in most cases. You may not be able to get a guarantee for a student loan discharged unless you can prove that paying off the loan would result in an undue hardship.