What Is a Guarantor?
A guarantor is a financial term describing an individual who promises to pay a borrower’s debt in the event that the borrower defaults on their loan obligation. Guarantors pledge their own assets as collateral against the loans. On rare occasions, individuals act as their own guarantors, by pledging their own assets against the loan. The term “guarantor” is often interchanged with the term “surety.”
- A guarantor guarantees to pay a borrower’s debt in the event that the borrower defaults on a loan obligation.
- The guarantor guarantees a loan by pledging their assets as collateral.
- A guarantor alternatively describes someone who verifies the identity of an individual attempting to land a job or secure a passport.
- Unlike a co-signer, a guarantor has no claim to the asset purchased by the borrower.
- If the borrower defaults on their loan, then the guarantor is liable for the outstanding obligation, which they must meet, otherwise, legal action may be brought against them.
Understanding a Guarantor
A guarantor is typically over the age of 18 and resides in the country where the payment agreement occurs. Guarantors generally exhibit exemplary credit histories and sufficient income to cover the loan payments if and when the borrower defaults, at which time the guarantor’s assets may be seized by the lender. And if the borrower chronically makes payments late, the guarantor may be on the hook for additional interest owed or penalty costs.
Types of Guarantors
There are many different scenarios in which a guarantor would need to be used. This ranges from assisting people with poor credit histories to simply assisting those without a high enough income. Guarantors also don’t necessarily need to be liable for the entire monetary obligation in the guarantee. Below are different situations that would require a guarantor as well as the type of guarantor in a specific guarantee.
Guarantors as Certifiers
In addition to pledging their assets as collateral against loans, guarantors may also help individuals land jobs and secure passport documents. In these situations, guarantors certify that they personally know the applicants and corroborate their identities by confirming photo IDs.
Limited vs. Unlimited
As defined under the terms of the loan agreement, a guarantor can either be limited or unlimited, with respect to timetables and levels of financial involvement. Case in point: a limited guarantor may be asked to guarantee a loan only up to a certain time, after which the borrower alone assumes responsibility for the remaining payments and alone suffers the consequences of defaulting.
A limited guarantor may also only be responsible for backing a certain percentage of the loan, referred to as a penal sum. This differs from unlimited guarantors, who are liable for the entire amount of the loan throughout the entire duration of the contract.
Other Contexts for Guarantors
Guarantors aren’t solely used by borrowers with poor credit histories. Pointedly: landlords frequently require first-time property renters to provide lease guarantors. This commonly occurs with college students whose parents assume the role of the guarantor, in case the tenant is unable to make the rent or prematurely breaks the lease agreement.
Guarantors vs. Co-Signers
A guarantor differs from a co-signer, who co-owns the asset, and whose name appears on titles. Co-signer arrangements typically occur when the borrower’s qualifying income is less than the figure stipulated in the lender’s requirement. This differs from guarantors, who step in only when borrowers have sufficient income but are thwarted by lousy credit histories. Co-signers share ownership of an asset, while guarantors have no claim to the asset purchased by the borrower.
However, in the event the borrower has a claim against a third party that has caused the default, the guarantor has the right to invoke a process called “subrogation” (“step into the shoes of the borrower”) in order to recover damages.
For example, in a rental agreement, a co-signer would be responsible for the rent from day one, whereas a guarantor would only be responsible for the rent if the renter fails to make a payment. This also applies to any loan. Guarantors are only notified when the borrower defaults, not for any payment before that.
In the event of a default, the guarantor’s credit history may be adversely affected, which may limit their own chances of securing loans in the future.
In essence, a co-signer takes on more financial responsibility than a guarantor does as a co-signer is equally responsible from the onset of the agreement, whereas a guarantor is only responsible once the primary party to the contract fails to meet their obligation.
Advantages and Disadvantages of Guarantors
In an agreement with a guarantor, the advantages usually lie with the primary party in the contract, whereas the disadvantages usually lie with the guarantor. Having a guarantor means that the loan or agreement has a higher chance of being approved and much more quickly. Most likely, it can allow for borrowing more and receiving a better interest rate. Though loans with guarantors tend to have higher interest rates.
In a rental agreement, one way to avoid needing a guarantor is by paying a few months of rent upfront if you are in a position to do so.
The disadvantages lie with the guarantor. If the person you are guaranteeing fails to pay their obligations, then you are on the hook for the amount. If you are not in the financial situation to make the payments, then you are still liable for the amount and your credit score will be negatively impacted and legal action may be taken against you. Also, if you guarantee a loan then your ability to borrow additional money for something else is limited because you are tied to an existing obligation.
Helps a borrower obtain a loan or a rental much easier.
Allows for the ability to borrow a higher amount.
Can help the borrower improve their credit history.
The guarantor may be liable for the outstanding obligation.
The guarantor’s credit score could be negatively impacted.
The ability to obtain another loan for a separate use is limited.
Is a Guarantor a Co-Signer?
Though the terms are used interchangeably, they are both different. A co-signer takes on equal responsibility in an agreement, co-owns the asset, and is responsible for payments from the start of the agreement. A guarantor is only responsible for payments once the primary party of the agreement defaults and is then notified by the lender. A co-signer has more financial responsibility than a guarantor.
Is a Parent a Guarantor?
A parent can act as a guarantor and often does for a child for their child’s first rental property, as the child’s income is usually not high enough at a young age.
How Do You Qualify as a Guarantor?
Different agreements and different lenders have different requirements for a guarantor. At the minimum, a guarantor will need to have a high credit score without any issues on their credit report. They will also have to have an income that is a certain multiple of the monthly or annual payments.
How Much Do You Need to Earn to Be a Guarantor?
There is no specific amount that an individual needs to earn to be a guarantor. The amount relates directly to the loan in question or the rent on a property. For rental agreements, landlords usually expect the guarantor to have an annual income that is at least 40 times the monthly rent.
What Happens If a Guarantor Cannot Pay?
If a guarantor cannot pay, both they and the tenant are liable for the obligations. The lender will begin collection proceedings against both the guarantor and the tenant, which will adversely impact the credit profile of both.
The Bottom Line
A guarantor is an individual that agrees to pay a borrower’s debt in the event that the borrower defaults on their obligation. A guarantor is not a primary party to the agreement but is considered as additional comfort for a lender. A guarantor will have a strong credit score and earn a sufficient income to meet the obligation.
Having a guarantor on a loan agreement greatly benefits the borrower. It allows for an agreement to be approved much faster and often at a higher amount.
In the event a borrower defaults, the guarantor must meet the obligation. If they do not, they are still liable and can have a lawsuit brought against them for the outstanding amount. They will also see a negative hit on their credit score.
View more information: https://www.investopedia.com/terms/g/guarantor.asp