Understanding the risks of Guarantor Loans
If someone has asked you to be a guarantor for a loan, you might be feeling like you want to help, but are nervous about taking on this responsibility. You want to do the right thing but not at the expense of your own financial security. If you’re considering saying yes, it’s critical you understand exactly what a Guarantor Loan is and more importantly what happens if the borrower fails to make a payment.
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What is a Guarantor Loan and should you avoid them?
In a nutshell, a Guarantor Loan is a type of loan that you take out with someone, but you will only make payments towards the loan if the main borrower cannot pay them. Unless you are extremely well backed financially, this is very risky.
Let’s look in more detail at the risk involved and what you could do instead.
How does a Guarantor Loan work?
With a Guarantor Loan, the original borrower signs a Consumer Credit Agreement directly with the lender, whereas the guarantor is part of an agreement but not the direct borrower. As a result, the guarantor may not be protected by important aspects of Section 7.3 of the FCA Handbook. This is key because it means that any methods described in the Token Payment Method when it comes to dealing with your debts may not be valid. The lender is essentially free to pursue more proactive collection practices.
Most critically, if the original borrower fails to make the contractual payments the debt becomes the guarantor's responsibility.
What happens if loan payments are missed?
If the guarantor has been called upon to take over the loan payments and does not make the full payments every month towards the debt, the loan may be defaulted. This may then lead to legal recovery action, not excluding a County Court Judgement. Lenders that provide borrowing based on a Guarantor Loan are quite strategic with who they choose to be the guarantor. They will usually suggest a person who:
- Has an emotional attachment to the borrower (like a family member, spouse, relative or a close friend)
- Has assets (like a property)
The emotional attachment is to reduce the risk of the borrower defaulting on the payment. Whereas the guarantor's assets give the lender the opportunity to secure the debt should the guarantor also default. In a nut-shell these are two tactics with one purpose, to secure their payment.
Don't forget to read The Real Debt Guy's final thoughts below!