Should I Be A Guarantor For My Friend's Loan?
Pros and cons of becoming a guarantor
What is a guarantor?
Being a guarantor helps a friend or family member get a loan or mortgage. It means that you are promising to pay the loan should the person you are helping become unable to pay. It cannot only affect your outgoing payments and expenses, if you have to start paying for the loan, but it can affect your credit score as well. For these reasons, it's imperative to make sure that you know the person you are helping very well. As an example, parents are often guarantors for their adult children to help them get a loan for a house or car.
Why do people need a guarantor?
Individuals need a guarantor when they have a low credit score or other demerits on their credit report. These factors make banks and other lenders reluctant to lend money because of the increased risk of failure to repay the loan.
As mentioned earlier, young adults don't always have a long credit history or proof of responsible loan repayment for the simple reason that they are just starting out in life. A guarantor, such as a parent or other close family member can provide the assurance to the bank that should the original applicant fail to pay, they will be responsible for repaying the loan.
Other reasons to need a guarantor include being a new immigrant with no credit history in the country, starting a new job, or having some other black mark on their credit.
Who can be a guarantor?
To become a guarantor you need to be over 21 and have a good credit report. You'll also need financial stability. You need to have a separate bank account from the applicant. Successful guarantors often have stable employment and are frequently homeowners with a sound credit score.
Why would I want to be a guarantor?
You should only be a guarantor for someone you trust and are willing and able to cover the repayments for. Often, guarantors are parents, grandparents, uncles, aunts, and close friends. Both parties should consider not just the financial burden of non-payment of the loan, but the emotional impact. Failure of the original loan applicant to pay the monthly installments can end friendships and cause family rifts if the guarantor is forced to pay the loan. Guarantors should know the applicant well enough to have a frank discussion about their finances.
Do I have to be a guarantor for the whole length of the loan?
You are the guarantor for the life of the loan. The only way that you will not be the guarantor is if the loan is paid or the applicant refinances the loan without you. Your financial stability had an impact on the approval of the loan in the first place and a lender will not change those parameters down the line.
However, if you sign an agreement as a limited guarantor, you may be asked to guarantee a loan only up to a particular time or only after to a certain amount has been repaid. After the conditions have been met, the original applicant assumes sole responsibility for the remaining payments.
Will being a guarantor affect my credit score?
In the process of applying for the loan, the lender will perform a ‘soft' credit pull on your credit. Soft credit searches aren't visible to other companies and won't affect your credit score. As long as the applicant makes the loan repayments, your credit will be unchanged. However, if the loan falls into default, your credit will show this impact as well. If you fail to make the payments as well, it will have a larger impact on your score and finances in general.
Will being a guarantor affect my ability to get a loan?
If you apply for a loan yourself, the lender will look at all aspects of your finances. If you are the guarantor for a large loan, your lender will take that into account as they decide if you are a good risk for your own loan. Should the loans you are a guarantor on go into default, that may impact your ability to pay back your own loan.
What is the difference between a co-signer and a guarantor?
Unlike a co-signer, a guarantor has no claim to the asset purchased by the borrower. A co-signers name appears on the title of the property being purchased by the loan. If the original loan applicant defaults on a car loan, for example, you will have no legal way to force the sale of the car to pay off the loan. A co-signer is equally responsible for making the repayments for the life of the loan, yet a guarantor is not responsible for making payments until the loan falls into default.
Questions to ask:
- ♦ Make sure that the applicant has the means to repay the loan in the first place. What are their income and expenditures?
- ♦ Know why they need a guarantor. Is it bad credit or simply not enough credit history? If they're asking you to put your credit on the line then you should have a clear understanding of the state of their credit.
- ♦ Do you trust this person to be responsible for the loan? If you have doubts about their financial responsibility in the past, you might save yourself the headache and decline their request.
- ♦ Can you afford the loan payments should the person stop paying. If the loan goes into default, you will be on the line to make these payments.
Read More: Blueprint To A Stronger Financial Foundation
The advantage of having a guarantor lies mostly in the applicant's favor. Loans can be approved more quickly and for higher amounts with a guarantor in good standing willing to sign. The guarantor assumes the risk of having to pay for a loan or rental agreement that they do not reap the benefit of. Bottom line: choose carefully who and for what you agree to be a guarantor.
Lori Stratford is the Digital Marketing Manager at Navicore Solutions. She promotes the reach of Navicore's financial education to the public through social media and blog content.