Guarantor on a Personal Loan? 5 risks you need to know about

Posted June 2017 by NZCU Baywide

personal loan guarantor

Kiwis are always looking to lend a hand, but what would you say if a friend or family member asked you to be a guarantor for their new personal loan? Yes? No? Maybe? Would you even know what you’re getting yourself into if you did?

Banks and credit unions will often offer you the opportunity to achieve a lower rate and increase your chances of approval by having a third-party act as additional security - a guarantor - on your application.

With mounting debts and skyrocketing house prices, it isn't uncommon to see New Zealanders pitch in and guarantee a loan for a friend or family. But while it may help them, it can also put you at risk. If the borrower falls behind in their payments, the lender may ask you to come up with the cash which could leave you saddled with repayments you weren't planning for.

So are your concerns justified? Is it really that risky to act as a guarantor on someone’s loan? Today we’re looking at the 5 major risks you should consider before you sign on the dotted line.

To start, let’s take a look at the pitfalls of unlimited guarantees…

1. Unlimited guarantees could trip you up

Signing up as a guarantor is simple, but there’s more to it than simply scribbling your signature.

For starters, you need to consider the kind of agreement you're signing. The most common guarantee is an unlimited guarantee, which makes you jointly responsible for any subsequent borrowings or liabilities that the borrower may enter into.

Take a home loan, for example. In this case, you could be responsible for far more than the initial amount, including any future increases or borrowings.

If you are considering the possibility, then look for a limited guarantee whenever possible. Offered by most financial institutions, they provide you increased protections, and limit both the amount you're liable for - and the length of time you'll be held responsible - should the borrower fall behind in their repayments.

So when it comes to the type of agreement you sign, check the fine print, ask questions, and make sure you know what you're signing up for. Remember, it can be difficult to get out of a personal loan guarantee once you've signed up, so do your homework before you put pen to paper.

2. Co-borrower or guarantor - there’s a difference

It can be easy to confuse the two at times, but there’s a big difference between being a co-borrower, and acting as a guarantor. In most cases, a co-borrower is jointly responsible for the entire amount, and has a deep financial interest in the assets that are being used to secure it.

For example, yourself and your partner might apply as co-borrowers for those home renovation projects you’ve been planning, which would see you both sharing equal responsibility for paying back the full loan amount.

A guarantor on the other hand is only linked to the loan, and isn’t responsible for making payments until such a point that the borrower fails to meet their financial obligations.

3. Things can - and do - go wrong

The borrower asking you to guarantee their loan might be a close friend or family member. What's more, they're always trustworthy, have a great financial record, and could repay the loan in next to no time. So what's the big worry?

It turns out that trying to predict your own future is difficult enough, let alone the financial future of someone else. From a breakup to a business failure, any number of events could see the borrower defaulting on their loan and leave you picking up the pieces. 

As the saying goes, it's better to be safe than sorry. So while you might not be able to predict it you can - and should - prepare for all possible outcomes. Consider what would happen if push came to shove, and you were left carrying the burden of someone else's loan repayments. Would you be able to cope?

4. Getting a loan could become more difficult 

It can be difficult enough to manage your own finances at times, and financial institutions know it. This is why stepping into the role of guarantor could make it difficult for you to get a loan in the future.

Why? Because as a guarantor, you’re effectively taking on the financial responsibility of another person in addition to your own. With the possibility of repaying this additional loan hanging over your head, lenders could decide that you can't afford to make repayments on another if the worst were to come to pass.

In the event that the borrower couldn't make their payments, you might have to repay the guaranteed loan in full before you apply for a new loan of your own. Would you be comfortable shelving plans for a new car or that dream wedding for someone else?

5. Your credit score could be at risk

When you sign on the dotted line as a guarantor, this is recorded in your credit report. If the applicant defaults on this loan, this will also be recorded, and the lender will likely look to you for repayment.

As this report is used by other financial institutions as a measure of your eligibility for anything from a loan application to signing up for certain utilities, a default here could negatively affect your credit score, not to mention put you at risk of further marks on your record if you're unable to meet these unexpected repayments.

With your credit score on the decline, it would be that much more difficult to apply for finance to consolidate your debts, or at the very least see you paying a higher interest rate on any loans you are approved for.

Still can’t decide? Here’s 5 questions every guarantor should ask themselves:

So you’ve weighed up the pro’s and con’s, but you still can’t quite decide if being a guarantor is worth the risk. To make the decision easier, here’s a few questions you should ask yourself before you sign on the dotted line.

  • What would you be willing to risk as security, and how would you feel if that item was repossessed if the money can’t be paid back?
  • Is the borrower financially responsible, and do you feel they’re capable of repaying the loan?
  • What are the reasons the borrower requires you to be a guarantor in the first place? Are they self-employed? Do they have a poor credit score?
  • Is the loan a sensible one, and would you apply for a similar one if you were in there situation?
  • Could they save with a high interest savings account or a term deposit instead?
  • Do they really need a secured loan, or could an unsecured personal loan work just as well?
  • Would you be able to repay the loan in full - including any interest - if the borrower is unable to do so?

Being a guarantor isn’t without risks, so get to know them

We know Kiwis are a helpful bunch, but before you decide to become a guarantor you should stay informed and weigh up the benefits and risks that you might face if things don't go as planned. With a little planning, preparation, and the points we’ve covered today, you’ll be able to make the right decisions for yourself, your friends, and your family should the question ever arise.

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