What Is A Guarantor Loan?
A guarantor loan is a financial product that is designed for friends or family to give their loved one a leg-up or little assistance when looking for a loan. It could be a suitable product for someone who has a bad credit profile or an insufficient background, such as young person who has never had to take out a loan before.
Guarantor loans are typically a type of personal loan and helps individuals find a deal that is affordable and provides the opportunity to improve or curate a healthy credit score. Although, it is possible to get a guarantor caveat on other financial products like a payday loan, or in other circumstances, such as for tenancy agreements.
A guarantor co-signs a loan agreement to help secure it for someone they know. There are specific requirements for a guarantor because a risky looking borrower naturally cannot incentivise lenders or show a loan is secure for another risky borrower. This is not to be confused with a secure loan.
A guarantor loan is usually an unsecure loan, which simply means that there is no commodity up for collateral, such as a pension account, car or property.
What Is The Role Of A Guarantor?
The role of a guarantor is simple; they will have to co-sign a loan agreement to secure it, but they also promise to meet the repayment schedule if the primary borrower fails to do so. Therefore, they act as a back up which puts the lender at ease, because they are confident they will get the anticipated return from a loan from either the borrower or the guarantor.
This can actually lead to reduced APR or more advantageous interest rates, reducing the overall cost of a loan, because the risk of lending has been offset.
The Effect On Your Credit Score
Deciding to be a guarantor for another person will not appear on a credit file. Of course, this is dependent on the primary borrower meeting their repayments. If called upon to pay the balance at any time during the term of the loan, a note will be made against your credit score, potentially lowering it. Potential creditors in the future will be able to see this.
Before opting-in, potential guarantors should note that they will be subject to the same credit checks (and affordability checks, depending on the lender and the type of loan) as the primary borrower.
The Benefits Of Using A Guarantor Loan
A guarantor loan is particularly beneficial for the primary borrower because it may provide them access to rates and loan types that they were previously disqualified from as a sole borrower on standard financial products, sans guarantor.
Around 51% of loan applications do not get the APR rate that is initially advertised because the lenders adjust the cost of the loan to offset the risk of the borrower. This indicates just how many people may be faced with high cost loans they simply cannot afford. Asking for someone they know to co-sign a loan may reduce the cost and keep repayments within an affordable bracket.
Furthermore, in an emergency financial situation, after someone has been rejected for a loan, they may start seeking riskier borrowing options such as expensive short term credit. A guarantor loan could also help borrowers avoid short term lenders that inflict APR rates of over 1000%.
Moreover, for those who are a little short on cash, it could also be more realistic to spread out the cost of a loan (even if this does work out a little more expensive) because the cost of missing a repayment could harm or lower a credit score.
With a massive increase in young people attending university in the last couple of decades, fees rising and an increase in the cost of living, a guarantor is also a unique way for young adults to feel financially independent and start cultivating a credit profile.
A guarantor loan does not mean that parents or others will be footing the bill, it just acts as a backup. This allows people to stand on their own two feet and build a credit profile for themselves for future borrowing.
What Are The Requirements?
Specific requirements for loans with a guarantor will differ from lender to lender. However, in the UK the general guidelines are:
- Must be someone the primary applicant has a prior relationship with; a relative or friend, for example.
- A good to fair credit score will also be a requirement, as another person with a bad or unestablished history will not encourage lenders or be able to show them that they will be able to meet repayments
- UK resident
- Aged over 21
- Has a regular income; this can be either be a dependable pension or standard wage. The minimum requirement for many lenders is £750 per month. This just shows the lender that they can meet the repayments if the primary borrower cannot whilst managing other living costs.
- Homeowners are usually a desired attribute for a guarantor, despite the majority of guarantor loans being unsecure, which means a commodity or asset is not put up to support the loan, it just establishes a dependable reputation for the guarantor. It also shows they have assets that can be used in the event of defaults.
- Be financially independent of the primary borrower
- Have a UK current account
Do You Need To Do Anything To Be A Guarantor?
A guarantor will have to fill out part of the loan application. If you are applying for a loan online, this can be done at a convenient time that suits you. It will ask for general information, including personal details, employment status and contact information. The information required will depend on the type of contract the guarantor is securing.
For example, a guarantor on a rental agreement (which is extremely common for student or young-persons tenancy agreements) may be asked to provide proof of address. This might be a utility bill or similar. This is nothing to worry about and is quite a common method of checking the validity of a guarantor.
Prospective guarantors might want to review their own finances to ensure they are capable of taking on an additional financial obligation if called upon. This might mean assessing their disposable income or available funds. The lender is also likely to ask for this information.
Will It Cost Money To Be A Guarantor?
It does not cost any money to become a guarantor, they are simply there to vouch for the primary applicant who should be intending to meet all the repayments and financial commitments themselves. However, as the safety net, it could cost to be a guarantor if the payment schedule is not met. If the loan goes to default or payments are late, the guarantor will be asked to cover the cost of the repayments and could also be liable for additional fees.
The terms of a guarantor loan will differ depending on the lender; in some situations, if the primary borrower is late or misses a payment a certain number of times (this could be just once), the guarantor will be asked to take over for the remainder of the loan agreement. In other cases, they will be asked on an as-required basis, covering single repayments rather than the whole term.
Who Should You Ask To Be A Guarantor?
Talking about money is a huge issue for so many people. In fact, research shows that failing to engage in open communication about personal finances could be affecting our relationships and result in more debt.
This could be complete debt denial which is not healthy. In this situation, an individual is likely to have bad credit, or at least outstanding debts, which means a guarantor loan might be the best option for them to secure reasonable financing. However, approaching a guarantor to ask could be quite awkward, especially if your relationship does not comfortably or regularly talk about financial matters.
As previously stated, you will need to have a prior relationship with any potential guarantor; a parent, a good friend etc. Yet you should not ask someone who is already financially dependent on you, for example, a spouse. This is because the lender will not be able to separately evaluate your finances and the loan will not look any less risky. You should be confident that the person you ask is responsible and will treat your guarantor loan seriously, although they may not need to have any involvement.
One of the vital things to make sure you ask, and get an honest response to, is your prospective guarantor’s financial standing. If you do not regularly talk about your finances, you may think you have an understanding of how much money they have and their existing debts.
This could be hugely inflated. You will need to ask about their current financial commitments, as this will impact their ability to repay a guarantor loan in the event that you default or miss a payment. Remember, when considering who to choose to co-sign a guarantor loan, you are financially binding yourselves together.
Borrowers may also wish to prepare answers to questions that their guarantor may ask, including how they plan to meet the monthly repayments and if they have a financial cushion or savings account that can be used to pay the loan.
As 53% of people under 30 are expected to not have any savings at all, if you fall in this bracket or do not have a reasonable financial cushion, you may think to draw up a budget to indicate how you plan to save and afford repayments.
Furthermore, the question of ‘why you need a guarantor’ may also come up. This may be uncomfortable if you are unaccustomed to financial conversations. Be prepared to explain financial mistakes that may have resulted in bad credit. Moreover, if you are a young person you may just need to explain your lack of a financial history which makes you an unknown entity to lenders. A guarantor loan could help to establish a positive credit score, if all payments are met as scheduled.
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Interesting related article:
- “What is a Secured Loan?”
- “What is an Unsecured Loan?”