What Risks are Involved in Guaranteeing a Loan? • What to take into account?

From a financial point of view, the risk of guaranteeing your children is the same as that of ensuring another unrelated person.

Apart from emotional considerations, being a guarantor entails a series of significant dangers that must be considered. We’ll analyze what a guarantor is and what the consequences of granting a loan may involve.

What does it mean to guarantee?

To endorse means that the guarantor provides a personal guarantee on a financial transaction of another person. For example, a father guarantees his son’s application for a mortgage loan.

Guarantors are usually requested by banks when they consider that the applicant’s credit possibilities are insufficient to cover with guarantees the risk of non-payment of a transaction.

What are the risks of endorsement?

A guarantor is an action that is considered as a joint and several liabilities for non-payment. That means that if the guarantor does not make the payments and they become in debt, the guarantor is responsible for the debt. The debtor must respond with their assets and property to the contracted obligations.

Therefore, the guarantor’s main risk is paying someone else’s debt. However, to reach a process of foreclosure of a guarantor’s assets, it is necessary to go through legal procedures driven by the claimant entity.  

Who can guarantee me

Any person of legal age with demonstrable creditworthiness, assets, and property can be a guarantor. There doesn’t need to be a family relationship.

Debtor or guarantor: who gets repossessed first?

In case of non-payment, the entity always goes to the direct debtor first. If the debtor does not have assets or property they can seize sufficiently to satisfy the debt, they will contact the guarantor.

Initially, the bank does not make a direct attachment to the guarantor. The entities claim payment of the amount from the debtor. However, there may be exceptional situations, especially in debts of long duration and in which the communication between entity, debtor, and guarantor has not been adequate.

In any case, the initial debt claim actions will always be against the debtor, and if they are unsuccessful, they will be against the guarantor.

What to consider before guaranteeing

Offering to be a personal guarantee in a financing operation is a complex financial decision that, if problems arise, can compromise the guarantor’s assets.

It is important, before agreeing to grant a guarantee, to evaluate aspects such as:

1. What type of operation is it?
2. What is the solvency of the guarantor?
3. What impact would non-payment have on the guarantor?

Without considering emotional factors, the risk of guaranteeing loans is the same as that of signing a guarantee for a third party. Contracts entail a financial responsibility to be taken into account and may pose a serious problem for personal finances in the event of enforcement.

Before granting the guarantee, a thorough study is necessary to guarantee the operation’s future. As we have seen, the execution in case of non-payment is not going to understand emotional issues. Before the lender, the responsibility lies with the guarantor, whomever they may be.

On the other hand, the greater the volume of financing in the loan, the more involvement the guarantor will have. That means more responsibility for the sponsor. This implies that in many cases, the guarantees will not be sufficient in terms of bank accounts or liquid money and will also involve property and real estate.

Limit the impact of a guarantor

One way to limit the impact of a guarantor is to adjust it as much as possible. That implies studying all options that reduce the amount of collateral. Keep in mind that lenders can negotiate this aspect in many cases, reducing the guarantor’s liability as long as the guarantor can provide some additional collateral.

For example, suppose the guarantor owns a property of lesser value than the financing. In that case, the lender may agree that the guarantor will assume the residual value of the transaction. That theoretically means that the guarantor will only take over the residual value in the event of default.

But that is the theory: if the guarantor does not respond with its collateral or claims that the collateral has lost value, it can extend enforcement to the supplementary guarantor.

In short, although it is a good tool that allows access to financing for many people, a personal guarantee should always be well-studied and considered before being approved.