If you're a business owner applying for a loan, or someone who's been asked to act as a guarantor, you might be wondering what exactly a guarantor is, why they’re needed, and how they fit into the loan process.
In this guide, we’ll explain everything you need to know about guarantors and how they can help businesses access the funding they need.
What is a business loan guarantor?
A business loan guarantor is a third-party individual who agrees to take responsibility for repaying a loan if the borrower (in this case, a business) is unable to repay it. This person provides a personal guarantee to the lender, offering extra security that the loan will be repaid.
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Guarantors are usually business directors, company owners, or trusted individuals such as family or friends with a strong personal credit history.
Why do lenders ask for a guarantor?
Lenders ask for a guarantor to reduce their risk and increase their confidence in lending. A guarantor acts as a safety net. For example, if the business is unable to repay the loan, the lender can turn to the guarantor to recover the outstanding amount.
Here are some common reasons why a lender might require a guarantor:
1. Limited Trading History
Newer businesses that haven’t been trading for long may not have built up enough financial history to give lenders confidence. A guarantor helps strengthen the application.
2. Poor or Limited Credit Profile
If the business has a low credit score or little credit history, lenders may worry about repayment. A guarantor with a good credit record can help ease those concerns.
3. Lack of Business Assets or Cash Flow
Some businesses don’t have assets or regular cash flow to secure a loan. A guarantor offers an alternative form of security.
4. Extra Reassurance for the Lender
Even for established businesses, a lender may want a guarantor to further reduce risk, especially with larger loan amounts or longer terms.
How can a guarantor help secure a business loan?
Having a guarantor in place can greatly increase a business’s chances of being approved for a loan, especially if the business has a limited trading history or a bad credit profile. In situations where a business might otherwise face application rejection, a guarantor provides an added layer of security for the lender, making them more comfortable with approving the application.
Here are some of the ways a guarantor can help secure a business loan:
- Improves Approval Odds - Lenders are more likely to say “yes” if there’s someone backing the loan personally.
- Access to Better Rates - With the added security of a guarantor, the lender may offer lower interest rates or better terms.
- Enables Larger Loans - Businesses may be able to borrow more if a guarantor is involved.
Who can be a guarantor?
While almost anyone can act as a guarantor, it’s important that they fully understand the commitment they’re making. A guarantor should be someone who trusts the business and is confident in its ability to repay the loan. Common guarantors include company directors, business partners, or trusted friends and family members.
Here are some key factors lenders typically look for in a guarantor:
- Good Personal Credit History - Lenders prefer guarantors with a strong credit score and clean financial record.
- Financial Stability - The guarantor should have a steady income or assets to cover the loan if necessary.
- Over 18 Years Old - They must be a legal adult and capable of entering into a binding agreement.
- Legal Understanding - It’s essential they know they’re personally liable if the business fails to repay.
What are the risks for a guarantor?
A guarantor will take on a serious financial commitment, so it’s important they fully understand the potential risks before agreeing. If you've been asked to act as a guarantor for a business loan, here are some points to be aware of:
1. Personal Financial Liability
If the business fails to repay the loan, the guarantor is legally responsible for making the repayments. This could impact their personal finances.
2. Impact on Credit Score
Missed payments or defaulted loans can harm the guarantor’s credit score, making it harder to obtain credit in the future.
3. Potential Asset Loss
In some cases, personal assets like property may be used to secure the guarantee. If the loan isn’t repaid, those assets could be at risk.
4. Strained Relationships
If the guarantor is a friend or family member, taking on this responsibility could strain the relationship if financial issues arise.
Before you decide
A guarantor can be a vital part of helping a business access funding it might not otherwise qualify for. However, it’s not a decision to take lightly. While the business gains an opportunity to grow, the guarantor takes on significant financial risk.
Whether you're a business owner considering asking someone to guarantee your loan, or you're thinking about becoming a guarantor yourself, make sure you fully understand the responsibilities involved. It’s always a good idea to speak with a financial advisor before making any commitments.
