If you are struggling to get a personal loan – perhaps due to a low income or a poor credit history – a guarantor loan can open the door to borrowing because it requires the financial backing of a friend or family member. But, the loans come with risks, so both parties should to their homework first.
What is a guarantor loan?
A personal loan, but where the borrower must be supported by someone else – the guarantor.
The person acting as the guarantor agrees to meet the loan repayments in the event the borrower is unable to pay, effectively ‘guaranteeing’ them and enabling the lender to advance the money at a reasonable rate of interest.
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Who can be a guarantor?
The guarantor should be someone you know very well – usually a close family member or friend. In many cases a parent acts as the guarantor for their child, for example. But the guarantor must not have any financial link to the borrower, such as a joint bank account.
Guarantors usually have to be over the age of 21. The guarantor will need a strong credit history and a UK bank account. Some lenders require the guarantor to be a homeowner.
What are the drawbacks?
The interest rates charged on guarantor loans are typically higher than that of an ordinary personal loan (without a guarantor). There may also be fewer choice of providers when shopping around for a guarantor loan compared to the wider personal loan market.
Clearly, using a guarantor arrangement could place a strain on the relationship between the borrower and the guarantor if the borrower runs into repayment problems and the guarantor has to step in to pay.
Guarantor loans can offer borrowers a chance to rebuild their credit history where they may have had problems in the past. But borrowers need to be honest with their guarantor about their financial situation and ability to pay.
Guarantors must feel satisfied they can trust the borrower and that the lending is affordable for the borrower to manage – and also that they, the guarantor, could comfortably meet the repayments if things were to go wrong.
What are the risks for the guarantor?
When a guarantor agrees to back the loan they become responsible for making the monthly repayments if the borrower defaults and cannot pay.
The term of the loan could be long – five years, for example – and guarantors are not able to remove themselves as a guarantor until the loan they are backing has been repaid in full.
If the loan is ‘secured’ then the guarantor’s home could be at risk if the borrower defaults on the repayments and the guarantor is also unable to pay. This is not the case for unsecured guarantor loans, but the lender will still pursue the guarantor for the repayment of the debt, possibly via the courts.
It is important to ask the lender how they record the guarantor loan account with the credit reference agencies before the borrower takes out the loan. If it is deemed a joint loan account, it will immediately show up on the guarantor’s credit history, which need not be an issue if the loan is properly serviced and repaid.
In some cases the loan will only appear on the credit file of the borrower. However, if the borrower misses a payment and the guarantor is called on to make their expected payment to cover the default, then a record will usually appear on the guarantor’s credit file at that point.
This could negatively impact the guarantor’s own credit rating and their ability to get credit in the future because lenders might infer that they are financial stretched.
Ombudsman concerns
The Financial Ombudsman Service (FOS), which deals with consumer complaints about regulated financial products, has seen a big increase in complaints about guarantor loans.
In particular the FOS sees many complaints from borrowers that the loan was unaffordable and that insufficient checks were carried out by the lender.
Complaints made by guarantors include that the stated guarantor had not agreed to the arrangement, or that the implications of being a guarantor were not properly explained at the outset. Some complain about unexpected damage to their credit record.
It is essential to read any small print of the loan agreement and contract before signing up – that goes for the borrower and the guarantor.
Both parties should they are aware of the risks and obligations, as well as how information about the loan will be recorded with the credit reference agencies.
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