Buying a first home is still seen by millions of Britons as a rite of passage, allowing people to set up a family of their own and start paying into an asset that they actually own. But for many people, it feels like a next step that is increasingly out of reach, particularly for young […]
A Guide to Guarantor Loans
When it comes to all things related to finance, it pays to research the ins, the outs and everything in between. This is especially true when it comes to loans; when managed correctly, they can be incredibly beneficial, but they can be extremely costly and can seriously damage an individual’s financial standing if utilised poorly.
While most people are fully aware of what a mortgage is for and have a firm understanding of how ‘traditional’ loans work, some types of loans are not so well-known. Guarantor loans certainly fall into this category.
So, with that in mind, let’s take a look at all elements associated with guarantor loans to see what they can be used for, who is liable to benefit, advice and guidance around how to make use of them, the pros, the cons, and what is – and could be – required of any guarantor.
What Does the Word ‘Guarantor’ Mean?
In the simplest of terms, a guarantor is an individual who agrees to take on responsibility for a loan that has been taken out by someone else. Usually, the guarantor will be a parent or guardian, but this is by no means written in the law; a guarantor can be anyone, but they must be fully aware of the associated obligations and the potential repercussions.
What Exactly Are Guarantor Loans?
As the above section implies, a guarantor loan is a type of loan – nearly always unsecured – that involves a secondary individual who agrees to take on the responsibilities associated with repayments and any potential charges or debts should the borrower be unable to pay back the money owed. As stated above, this is nearly always a parent or a close friend with a secure income, but there are times when other individuals will be more suitable. Again, everyone’s circumstances are different.
What Does a Guarantor Have to Do?
A guarantor signs an agreement stating that should the individual who has been given the loan not repay what is owed, they will shoulder the burden. The guarantor agrees to take full responsibility; if the borrower of the loan misses a solitary repayment, the lender can then choose to target the guarantor to ensure that it does not find itself in a state of financial detriment.
Some guarantors will also have additional responsibilities, but these tend to depend upon the methods utilised by the specific lender. For example, some lenders may be unwilling to pay any loan amount directly into the borrower’s account; rather, they will send the money to the bank account of the guarantor, and they will then be responsible for forwarding the funds. This can then be dished out piecemeal or all at once – it is entirely up to the individuals involved to come to some agreement.
Who Is Allowed to Be a Guarantor?
There are certain rules around who is allowed to be a guarantor. The main thing any lender wants to see is that any guarantor is fiscally stable and will be able to come through on their promise of repaying any outstanding money should such a situation occur. Though rarely explicitly stated, the things lenders like to see when assessing whether they will accept a guarantor are that they own their own home, that they have a secure job, achieve a decent wage, and are not financially tied to the borrower already (via a bank account, for example). All guarantors also need to be over the age of 21.
Who Can Make Use of a Guarantor Loan?
Generally speaking, such loans are the preserve of those that do not have a very good credit score or have not accumulated a robust credit history and whose only other alternative would be a bad credit loan. This can be for many reasons, such as only recently moving to the country, being a student or having only recently graduated, or being out of work for an extended period of time.
A guarantor may be required for such an individual to take out a loan – regardless of what the loan is for – should they find it difficult to be approved for a loan on their own. When a bank or finance lender decides to give an individual a loan of any kind, they do so under the understanding that the money will eventually be paid back; if someone has a poor credit score or no history, then, simply put, the lender will not have any confidence that it will not end up out of pocket.
Rates of Interest
Generally speaking, a guarantor loan will have a higher rate of interest when compared to a more ‘standard’ loan; this is largely because the borrower has no history, and it is therefore tough for the lender to assess how likely it is that it will be able to get its money back. The lender considers any loan to someone with poor or no credit history to be risky, and the interest rates will reflect this.
There is no set interest rate or annual percentage rate (APR) that is related to all guarantor loans; the total amount that will have to be paid back will be related to how much money is being borrowed, how long the loan is set to last for, which lender the money is being borrowed from, and a variety of other personal circumstances that will be assessed before the lending process beginning.
Several pros come with a guarantor loan. The big three are:
1. They are available to nearly everyone. People with a bad credit score, or no credit history, can attain one, meaning they can get enough money together to purchase something like a car, or launch a business, even if their financial history hasn’t been particularly positive.
2. If the borrower needs a lot of money – more than they would be able to get from any other loan – then the best bet is probably a guarantor loan. Because they are designed for people with poor credit, and because the lender has a safety cushion in the form of the guarantor, it is possible to attain a relatively significant sum (though this will vary from lender to lender).
3. A guarantor loan can actually help the borrower build their credit score. As long as they commit to making all necessary payments at the correct time and continue with the loan contract until its conclusion, they will showcase that they are capable of being trusted to borrow money and will subsequently be able to borrow additional funds in the future without the need for a guarantor to be involved.
It should also be noted that, as with all loans, there are potential downsides. The big three are:
1. The rates of interest are, generally speaking, very high. Some lenders will have higher interest rates than others, and it is vital to assess numerous options before signing any contract.
2. As with any loan, failing to make payments can result in the borrower’s credit score being damaged. Therefore, paying back a loan on time is vital regardless of the type, and it is absolutely no different with regard to a guarantor loan.
3. There is always the chance that the relationship between borrower and guarantor could be strained during the process if payments are not made or if either party finds that they encounter financial difficulties. Both the borrower and the guarantor need to be very aware of what they are getting involved with and then assess whether the relationship is strong enough to survive any potentially tough times.
Associated Risks of Being a Guarantor
Agreeing to be a guarantor is by no means a decision that should be undertaken lightly. There is always a chance that it could end up being financially damaging, so it is essential to know what the risks are beforehand.
The biggest risk is, of course, that the guarantor will end up having to pay back the loan that has been taken out. Therefore, an individual should only agree to become a guarantor if they are fully confident that the primary borrower is in a position – or will be in a position – to fulfil any repayment requirements. It is certainly worth noting that if they are unable to pay the loan back, it could damage the guarantor’s financial score and the borrower’s. This could, ultimately, make it far more difficult for both parties to attain any loan in the future.
It should most definitely be considered that it is not possible to back out of being a guarantor after all paperwork has been signed and once any ‘cooling-off period’ has been and gone. Once this two-week period has elapsed, the contract will be fully in place, and all of the guarantor risks listed in this piece will become a reality.
It is strongly recommended that before signing any contract, a would-be guarantor ensures they have read and digested all associated documentation thoroughly, are fully aware of how the borrower expects to be able to pay back the amounts they owe, and potentially even sign an additional contract with the borrower to state how they will be paid back (if that ends up being necessary).
Being a Guarantor and Credit Score Impacts
Some guarantors do not realise that there could ultimately be a significant credit score impact if the borrower reneges on any deal or finds themselves unable to pay the loan amount back. If the money is all paid back as planned and on time, then a guarantor’s credit score will not be tarnished in any way; however, should the borrower struggle to pay back any money, the loan could end up being added to the credit score of the guarantor, which could put a huge black mark against their credit record.
Frequently Asked Questions
Hopefully, the above guide has answered any questions you may have had about the process, but there are also some questions that we have been asked in the past that, though uncommon, may well be playing on your mind.
Q) If the main borrower dies, what happens next?
A) This will depend on the terms of the contract issued by the lender, but if the primary borrower dies, this is not necessarily a guarantee that the loan amount will be void. It could be that the guarantor will have to repay any outstanding amount.
Q) Is there any chance a guarantor could lose their home?
A) This is indeed a possibility. For example, should the borrower be unable to pay back the money that they owe, and if the guarantor is then also unable to pay back the amount, a ‘charging order’ could be issued, which could then result in the guarantor being forced to put their home up for sale.
Q) If someone asks me to be a guarantor, am I allowed to refuse?
A) You are in no way compelled to become a guarantor if someone approaches you, so do not be forced into doing something that makes you uncomfortable. However, it is worth noting that if you do agree to be a guarantor but then later decide against the idea, you will have to back out within what tends to be called a ‘cooling-off period’. This is usually around two weeks but could change from lender to lender.
Improving One’s Credit Score
A guarantor loan tends to be an option for those people with a poor credit score. And, while sometimes there are few other options available simply because the money is needed quickly, it absolutely makes sense to try and bolster one’s credit score so that interest rates can ultimately be reduced and loans can be simpler to acquire.
There are four simple tips to enhance a credit score:
1. Get registered on the electoral roll, as this means that lenders will be able to check your credentials quickly.
2. Consolidate any of your debts if that is at all possible, as that will ensure that all loans will be combined, meaning they can be managed easily, and all money can be paid in good time.
4. Get a credit card and then pay for small items frequently. If you can ensure that all purchases are then paid off, your credit score will rise quickly.