If you submit an application for a personal loan, the lender will generally determine your eligibility based on factors such as your credit history, your income, any debts you already have, your age and how much you are looking to borrow. They do this in order to figure out whether you will comfortably be able to service (i.e., meet the repayments on) your loan.
While you may not prove eligible for a certain personal loan, or loan size, due to your own financial circumstances, you could potentially improve your chances of being approved by having someone act as a guarantor for the loan. However, as we’ll see, this arrangement can be risky.
What is a guarantor personal loan?
A guarantor personal loan is a loan backed by a parent or a trusted person in your life who has agreed to accept financial responsibility if you cannot meet your repayments. Your potential guarantor will need to demonstrate to the lender they have the capacity to meet your loan repayments, if you can’t.
Both you and your potential guarantor may want to consider the risks of such an arrangement at length before entering into it, considering the significant financial burden that could be placed on the guarantor if you cannot meet your repayments.
Lenders may vary when it comes to the rules and requirements for guarantor loans, so it may be prudent to check with your lender of choice before asking someone to guarantee your loan. Given the commitment involved, it may also be worth considering seeking independent legal and financial advice before agreeing to being a guarantor for someone’s loan.
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What are the risks of going guarantor for a loan?
If you are thinking about becoming a guarantor for someone’s loan, you may want to consider some of the risks associated with this decision.
- Your credit rating may be affected if the borrower can’t meet the minimum loan repayments. For example, a default or non-payment on your credit report may make it difficult to borrow money in the future.
- If you have agreed to be a guarantor for someone else’s loan, you would need to declare that on any separate credit applications you decide to make in your own name in the future. This may impact your likelihood of being approved for the new credit.
- If you’ve provided an asset as security for someone else’s loan, you might not be able to use that security for your own loans in the future. You may also risk losing that asset if both you and the borrower default on the loan.
- A change to your relationship with the borrower won’t change your legal obligations as guarantor. If they default on the loan, you will need to pay the loan even if you no longer have a relationship with the borrower. You may want to carefully consider your relationship with the borrower before agreeing to guarantee their loan.
- Entering this kind of agreement could cause damage to your relationship with the person you’re acting as guarantor for, who may be a friend or family member, particularly if there ends up being issues with the loan being repaid.
If you’re considering becoming a guarantor for someone’s loan, you may want to closely consider all the pros and cons before making your decision. You could decide not to act as guarantor for the loan, but help in other ways, such as contributing to some or all of the borrower’s repayments to help them pay it off quicker. However, this would only be an option if the borrower is eligible for credit without a guarantor.
To avoid financial stress, you may want to seek professional financial advice or counselling, and thoroughly check the terms and conditions of the loan agreement before signing up to be a guarantor.
If you do become a guarantor, Moneysmart suggests it may be less risky if the loan is for a fixed amount, with a clear repayment term, so you know how much you are guaranteeing and for how long. It also explains that you may be able to challenge the loan contract if you were pressured into agreeing to become a guarantor, you had a disability or mental illness at the time of signing, or were misled or tricked. You may want to seek legal advice, which could be available for free in some situations, if you want to make a challenge to the agreement.
What’s the difference between a guarantor and co-borrower?
Whereas a guarantor agrees to become financially responsible for the loan only in the event that the original borrower defaults, a co-borrower is as equally responsible for the loan as the original or main borrower from the get-go. A co-borrower is subject to the same financial and legal penalties as the original borrower if payments are missed or the loan defaults, meaning the co-borrower’s obligations are the same as if they had taken the loan out personally.
Co-borrowing and having a guarantor for a loan achieve a similar purpose in that they may help someone borrow more than they would otherwise be able to. However, neither arrangement should be entered into without significant consideration and weighing of risks by all parties involved.
This article was co-written by James Hurwood. It was reviewed by our Sub Editor Jacqueline Belesky before it was published as part of our fact-checking process.
Main image source: Iakov Filimonov (Shutterstock).
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