If you guarantee a loan for a family member or friend, you are known as the guarantor. You are responsible for paying back the entire loan if the borrower cannot.
If a lender does not want to lend money to someone on their own, the lender can ask for a guarantee. Before you agree to be a guarantor, think carefully about your own finances. Make sure you understand the loan contract and know the risks.
Know the risks of being a guarantor
If you are guaranteeing a loan, make sure you understand the risks. Take the same care as if you were taking out a loan for yourself.
You may have to pay back the entire debt.
If the borrower cannot make the loan repayments, you will have to pay back the entire loan amount plus interest. If you can't make the repayments, the lender could repossess your home or car if it was used as security for the loan.
It could stop you from getting a loan
If you apply for a loan in the future, you will have to tell your lender if you're a guarantor on any other loans. They might decide not to lend to you, even if the loan that you guaranteed is being repaid.
You could get a bad credit report
If either you or the borrower can't pay back the guaranteed loan, it's listed as a default on your credit report. This makes it harder for you to borrow in the future.
It could damage your relationship
If you are a guarantor for a friend or family member who can't pay back the loan, it could affect your relationship.
If you don't feel comfortable guaranteeing a loan, there may be other ways to help. For example, you might be able to contribute some money towards a house deposit.
Understand the loan contract
Before you sign a loan guarantee, get a copy of the loan contract from the lender ahead of time. Ask lots of questions so you understand the details.
Check whether you will be able to meet the loan repayments if the borrower cannot. Work out the total you would have to pay back, including the loan amount, interest, fees and charges.
If you guarantee the total loan amount, you will be responsible for the loan amount and all of the interest. It may be better to guarantee a fixed amount so you know exactly how much you might have to pay if the borrower cannot.
You may have to use an asset — like your house — as security. This means that if the borrower defaults on the loan, the lender might sell your house to pay the debt.
A longer loan term may sound good, but you will pay more in interest. Be careful about guaranteeing any loan that has no specified end date, like an overdraft account.
If you are asked to go guarantor on a business loan, you must understand the loan contract. You should also find out everything you can about the business. Ask for a copy of the business plan to understand how it operates.
Speak to the accountant and look at financial reports. Make sure the business is financially healthy with good prospects.
Being a guarantor might not work out as planned. In most cases, if the borrower cannot make their repayments, you won't be able to get out of the loan contract.
You should speak to a lawyer to obtain legal advice about your situation.
CASE STUDY: Mary guarantees a business loan for her son
Mary’s son Leo has worked in hospitality for years. When he saw a popular local food franchise for sale, he thought it would be a great opportunity to run his own business.
The franchise director told Leo that the company had a strong brand, high profits and low costs. Leo thought it was a safe bet.
He applied for a $250,000 business loan with his bank. Mary agreed to go guarantor for the loan, using the family home as security.
Leo was hit with slower business and higher costs than he expected. After paying rent and franchise royalties, he is struggling to make his loan repayments.
Leo and Mary are talking to the bank about repayment arrangements. But the bank might sell the family home to cover the loan.
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