Who Can Act as a Guarantor?
Spouse: A spouse may provide a guarantee on a home loan or other type of loan. Guarantors may be required for investment properties. If a borrower has a high debt to income ratio, a guarantor may be required by the bank to borrow the amount requested. The spouse will help the borrower meet his or her financial obligations in the event of a difficulty.
Parent: A parent may provide a guarantee for an underage or adult child. The parent acts as assurance to the bank that the child will meet his or her obligations. In some instances, the parent may offer their home as collateral for the child. This collateral provides the bank with security.
Company Directors: A company may ask directors to secure a loan if the company does not have sufficient assets as a separate entity. The directors may use property to secure the loan or a family home to secure the debt for the company. When banks have assets to back their loans, they are more apt to lend to a company.
What is Required of a Guarantor?
A legal document called a guarantee is usually devised to indicate the terms of the loan. In the document, the responsibilities of the borrower and the responsibility of the guarantor are listed. If there are multiple guarantors, each of their roles is outlined in the document. The primary borrower is initially responsible for the entirety of the debt. If the borrower cannot meet his or her obligations or is in danger of a potential default on the loan, the responsibility will fall to the next guarantor in line. This process mitigates the risk of the bank.
How is the Guarantor's Borrowing Power Affected by the Role?
Being a guarantor for another person affects the guarantor's borrowing ability. Therefore, the borrower may not be able to receive a loan for his or her own purposes until the debt is fully paid off. Because of this, guarantors must plan ahead to determine how this will affect his or her ability in the future. Guarantors are advised to speak with legal counsel before acting as a guarantor to ensure their own borrowing potential will not be inhibited in the future.
Potential Problems Associated with the Guarantor Role
- If the borrower passes away, the guarantor is responsible for the loan.
- If the home is used as collateral, the guarantor may lose the home if he or she defaults on the loan.
- The guarantor may be required to pay, even if the loan is not under default.
- The relationship between the borrower and guarantor may become strained.