If you’ve ever considered taking out a loan with low income or a below-average credit score, you may have come across the term ‘Personal Guarantee’. When you sign up as a personal guarantor, you permit a lender to hold you accountable, if the debtor doesn’t repay the loan. Personal guarantee also plays a significant role in business loans, as they act as an assurance if a company goes into insolvency.
We’ve answered some of the most common personal guarantee queries, to help you get a better insight into the subject.
What is a personal guarantee?
Personal Guarantee is simply an assurance required by the lender, wherein an individual signs up as a guarantor, on behalf of the borrower. Now if the borrower does not meet the repayment obligations as per the agreement, the guarantor will be required to fulfill the obligations.
In case of business finance, if you, as the firm’s director, sign up for personal guarantee, then the lender will turn to you, should the firm fail to repay the loan.
A personal guarantee gives an edge to the lender, as it ensures that the agreement conditions are met, even if the guarantor repays the money.
When can a personal guarantee be used?
Personal guarantees may be used by lenders for assurance against applicants with an inadequate credit history to qualify for a loan otherwise. Small business owners, who don’t have enough funding may use the personal guarantee to take out a loan to support their venture.
What type of personal guarantee can you apply for?
The two most common types of Guarantees in case of business finance are:
Limited: In a limited guarantee, the lender is only allowed to acquire a capped percentage of the loan, from the guarantors. For instance, your board of executives sign up as guarantors for a business loan. Now that multiple guarantors can repay up to a certain amount, the lender can hold each guarantor accountable to repay 25% of the debt.
Unlimited: Unlimited guarantees are tricky, as they allow lenders to recoup the entire amount of the loan, from the guarantors. So if you have a board of 5 executives who signed up as guarantors, they will be responsible for repaying the loan in full. If the company goes into insolvency, and the guarantors don’t have enough liquid assets, the lender may seize their assets such as property or vehicles.
How enforceable is a personal guarantee?
It is important to understand that in case of personal guarantee loans, the guarantor’s liability to the lenders is coextensive with the borrower. This would imply that the guarantor’s liability will be released once the borrower’s liability ends.
However, if the borrower fails to comply with the obligations in the contract, the lender can take legal action to summon the guarantor involved. This will jeopardize the guarantor’s assets as the lender may seize them if there isn’t enough money to repay.
Typically, a contract gives the lender 6 years from the date of contract breach, to seek legal action against the guarantor.
How do you get around a personal guarantee?
If you want to avert the risk of being a safety net by signing up as a personal guarantor, here are some tips you can refer to:
- Get insured: Personal guarantee is as much a risk for the guarantor, as it is for the borrower. When your assets are on the line, it can take a toll on your mental health. Therefore, seek insurance for your guarantee, to alleviate the risk of the lender calling in your guarantee.
- Time your guarantee: Lenders use the personal guarantee to reduce their risk at lending money. You need to succeed at building relations with your lender, through timely repayments, or giving them more control over your company’s information. Once you prove your reliability, typically within 6-12 months, you can negotiate with the lender to cap the guarantor’s liability at 50%. Over the course of the next few months, they may further reduce it or finally terminate the guarantee if they see more improvement.
- Transfer personal guarantee: To eliminate yourself from a guarantor agreement, it is important to obtain permission from the lender. While lenders don’t usually agree on simply canceling guarantee, they may be able to transfer on to a new guarantor. However, before switching, the lender would want to ensure that the new guarantor is in a position to meet the contract’s requirements.
Is the UK banishing personal guarantee on loans?
In the light of the recent events, Chancellor Rishi Sunak announced a ban on personal guarantees on emergency loans below £250k. The Chancellor reinforced a new and improved CBIL scheme for small businesses to help them sustain the damage by the Covid-19 pandemic.
Under this scheme, the UK government will extend its support even to small businesses. As opposed to the former scheme, which only covered companies not getting commercial funding.
This has been a great step in mitigating people’s suffering owing to the pandemic as several small businesses collapsed due to the economic lockdown since March.
How long can a personal guarantee last?
An individual guarantor shall remain liable to the lender for as long as the loan term and repayment come to an end. Once the loan has been repaid in full, the guarantor will be free of any obligations.
The same applies to a personal guarantee loan for business financing. For instance, you are one of the board executives that signed up as a guarantor but you happen to leave your job. You will still be obligated to fulfill a guarantor’s responsibility. Leaving the job will not exempt you from abiding by the contract.