A personal guarantee is a legal agreement between a borrower and a lender. It states the borrower is answerable for repaying the loan. This personal guarantee vs insurance usually comes when a small business has little to no collateral to offer as security for a loan and can pay with cash or business credit card.
Personal guarantees can be beneficial and, at the same time, risky. However, we’ve compiled in this post, everything you need to know before signing one. Ready? Let’s dive in!
What Is A Personal Guarantee?
A personal guarantee is a formal promise to repay a debt if the borrower defaults. It makes the borrower personally liable for the debt and gives the lender the right to collect the debt if the borrower fails.
This guarantee is common in business financing, providing the lender with additional security. Personal guarantees can also be applied to other types of lending, such as mortgages and personal loans.
For business financing, this guarantee typically requires the guarantor to sign a legal document stating they are financially responsible for the debt. The guarantor may be required to provide collateral, such as property or assets, as additional security. If the borrower defaults on the loan, the lender can pursue the guarantor for repayment.
Furthermore, personal guarantees can be risky propositions for the guarantor. This is because they may be required to repay the debt even if the borrower can do so.
How Does Personal Guarantee Work?
A personal guarantee vs insurance works when a business has no funds or collateral for a loan, hopefully, to repay via a credit card. If the business defaults, the lender can pursue the borrower for repayment. That includes going after the guarantor’s personal savings, investments, and even their home if necessary.
On the other hand, the borrower may sell personal assets, such as a home or car, to repay the loan. In some cases, the borrower may be subject to wage garnishment or other legal action.
Thus, a personal guarantee gives the lender some assurance that the loan will be repaid, even if the business cannot repay it. This type of guarantee is in conjunction with a collateralized loan, which means the lender has the right to seize the collateral if the borrower does otherwise.
How to Obtain a Guarantee
To obtain a personal guarantee, the lender will typically require the individual to fill out a form and provide financial information such as income and asset information. The lender will also likely require the individual to sign the agreement that outlines the terms and conditions.
For this reason, personal guarantees are not taken lightly. Anyone considering signing the agreement form should ensure they are comfortable with the risks involved and confident in the borrower’s ability to repay the debt. They should also consult with an attorney to understand the full extent of their liability.
Types Of Personal Guarantees
There are two main types of personal guarantees. They are as follows:
#1. Limited Personal Guarantee:
A limited personal guarantee is a type of financial guarantee that limits the amount of money an individual is responsible for if a debt is yet to be cleared. You can use this type of guarantee in business financing arrangements. It can protect you from paying back more money if your business does not go well. This can be an attractive option for borrowers who cannot obtain a traditional guarantee from a family member or friend.
The downside of a limited guarantee is that it may not provide enough protection for the lender if something happens. In some cases, the guarantor may be liable for the entire loan amount if the borrower cannot repay the loan. This could lead to financial hardship for the guarantor. Therefore, it is best to carefully consider the risks and benefits of a limited guarantee before agreeing.
#2. Unlimited Personal Guarantee:
An unlimited personal guarantee is a type of financial guarantee that allows you to cover an infinite amount of money if you do not clear your debt. This is common in business transactions and it can have serious implications for the person that agrees to it. If the debt is still pending, the person or signer may be required to pay the entire amount plus any interest and fees.
Sometimes, the individual may also be held liable for any legal costs in line with collecting the debt. However, unlimited personal guarantees can hinder an individual’s credit score and financial stability, so it is important to vividly know the risks before agreeing to one.
How Strong Is A Personal Guarantee?
A personal guarantee is a very strong form of security for a lender. It means that the borrower is 100% responsible for the debt. Additionally, the lender can take legal action against him/her if not comply.
This means that if the borrower defaults, the lender can seize the borrower’s assets to recoup their losses. While this may seem like a risky proposition for the borrower, personal guarantees are obtainable at lower interest rates than regular loans.
How Long Is A Personal Guarantee Valid For?
Most personal guarantees are valid for the life of the loan. But some may only be valid for a specific period, such as six years.
What Is An Example Of a Personal Guarantee?
An example of a personal guarantee is when a small business owner with little or no funds obtains a loan from a bank to start her business, hoping probably to repay using a credit card. The business owner signs the guarantee agreeing to be personally liable if the company cannot repay the debt. If the business owner later does not pay, the bank can attempt to collect the debt from her.
Another example can be if someone agrees to pay a friend or family member’s debt. If the original borrower finds it hard to make the loan payments, the guarantor will cover the outstanding amount. This type of agreement can be beneficial, especially if the borrower has a history of financial difficulty.
Personal Guarantee Vs Collateral
Many people want to understand personal guarantee vs collateral, the truth is, about 80% of people use these terms interchangeably.
A personal guarantee is an individual’s promise to repay a debt if the business cannot. A collateral is an asset, such as a car or house, used to secure a loan. If the borrower cannot, the lender can take possession of the collateral.
Personal guarantees are more common for small business loans, while collateral is more common for mortgages and other loans from financial institutions. Hence, personal guarantees are less risky for lenders because they can take legal action against the borrower. And collateral is riskier because the lender may not sell the collateral for enough money to cover the loan.
The Difference Between a Personal Guarantee and a Personal Loan
A personal guarantee is when an individual agrees to stand the repayment of a debt should the primary borrower default on their payments. A personal loan is when an individual borrows money from a lender and is responsible for repaying that money, with interest, over a set period.
The main difference between the two terms is that a personal guarantee puts the responsibility for repayment on the guarantor rather than the borrower. That is, if the borrower defaults on their payments, the guarantor will be responsible for repaying the debt. A personal loan, on the other hand, puts the responsibility for repayment squarely on the shoulders of the borrower.
Meanwhile, a personal loan is a good option for borrowers with a steady income and good credit history. And do not forget to consult an attorney to guide you on which to apply.
What Is Personal Guarantee Insurance?
Personal guarantee insurance is insurance that offers protection to people who have personal guarantees in place for business loans. The insurance covers the repayment if the firm or organization fails to meet its obligations.
In addition, it gives peace of mind to borrowers and can help them obtain the financing they may not get.
Is a Personal Guarantee Legally Binding?
Yes, a personal guarantee is legally binding. It is more or less a powerful tool for lenders. But when you sign the form, you’re putting your assets on the line. Meaning, if you don’t follow the rules, the lender can come after your assets, including your savings, home equity, and even your wages.
So, understand the risks before you sign. And if you’re not comfortable with it, you can negotiate with the lender to find an alternative arrangement.
How Do You Provide a Personal Guarantee?
- To provide a personal guarantee, the borrower must sign a legal document agreeing to be in charge of the loan.
- The borrower should understand the terms of the agreement before signing, as it can affect their finances if something goes wrong.
- Finally, the lender may require the borrower to provide collateral, such as property or equity in the business, to get the loan.
Can You Get a Business Credit Card With No Personal Guarantee?
Many business owners always ask if they can get a business credit card without signing a personal guarantee. The answer is yes, but there are a few things to keep in mind:
- First, when shopping for a business credit card, ask if the issuer requires a personal guarantee. Some issuers may be willing to waive this requirement if you have a strong credit history and financials.
- Second, note that business credit cards without protection typically have lower credit limits than cards that do require a guarantee. So if you’re looking for a business credit card with a high credit limit, you may need to sign an agreement.
In essence, it is possible to get a business credit card without a personal guarantee but know all the above points, credit limits, and the issuer’s requirements.
Final Thoughts
In conclusion, a personal guarantee is a tool used to obtain financing, especially when a company seeks money for the first time or doesn’t have enough collateral to secure the loan, but it comes with many risks. For this reason, it is vital to consider the terms carefully before accepting them.
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