A guarantor loan is simply a loan that is guaranteed by a third-party. A person who guarantees a loan is called a guarantor. Anyone with good credit can be a guarantor. In order to guarantee a loan, lenders will normally run a credit check on the potential guarantor.
If that check is favorable, then you may be able to obtain a loan on better terms and with a lower interest rate than you could get on your own.Keep in mind that guarantor loans can be either secured or unsecured. A secured loan is simply one that has collateral behind it. Think of a home loan. A mortgage serves as collateral for the loan. If the borrower doesn’t pay, the bank gets the house. That is one example of a secured loan. Secured loans may or may not be the best loans for you, depending on a number of factors.
Guarantor Loans In Disguise
Guarantor loans come in all shapes and sizes. Consider student loans, for example. One type of student loan is called a stafford subsidized student loan. This type of loan has two features. The first notable feature, which is fairly obvious, is that the federal government subsidizes interest on the loan.
For example, consider a student entering a four-year college program. If that student took out a normal loan to finance his education, the money borrowed for year one of the program would accrue interest over the next four years. That would mean that at the end of the educational program, our hypothetical student would owe principal and the interest that had accrued over four years.
With a federally subsidized stafford loan, the federal government actually covers the interest payments for all four years of the education and for an additional six months after graduation from a degree program. That would save our hypothetical student a tremendous amount of money.
The second notable feature of federal stafford loans is that they are guarantor loans. The reason these loans are broadly available to students–people with limited or non-existent credit records–is that they are guaranteed by the federal government. Even though funded by banks, federal stafford loans are guaranteed by the government.
Drawbacks of Guarantor Loans
Guarantor loans make it easier for people with limited credit histories to establish and build credit. But guarantor loans do have some drawbacks. For one, there is more on the line than just the borrowers credit history. By guaranteeing a loan, a guarantor promises to “make good” on the loan obligations in the event that the primary borrower defaults. That can mean a lot of risk, and in some cases, difficulty in finding someone willing to guarantee a loan for you.
If you happen to default on a guarantor loan and the guarantor pays or settles with the creditor, you could have to answer to the guarantor, who might be able to change the terms of the original loan in a way that is unfavorable to you. Make sure you know your guarantor well and have a plan worked out in writing for how any defaults on your part will be handled and what will happen to the collateral backing up guarantor loans
No Guarantor Loans will help you establish personal credit faster, but they will be more expensive. Guarantor loans will help you establish credit, but they can be less effective at building credit histories than loans that are not guaranteed. Guarantor loans can even be effective in helping establish loans for the unemployed or bad credit car loans.
If a loan is reported as a guarantor loan, then credit agencies may “discount” the loan, and it can take you longer to build a strong, independent credit file. This is simply a trade off. If you want a low interest rate and have bad or limited credit, going with a guarantor loan is a good way to begin establishing positive credit.
Some Guarantors are Super Creditors
Keep in mind that all guarantors are not created equal. Remember the federally subsidized stafford loan we discussed earlier? Well, it’s true that such loans are guaranteed by the federal government. In effect, if you default on a federal student loan the bank that funded your loan will get paid by the federal government. Then you’ll owe the guarantor–the federal government.
Because the federal government is what I call a “Super Creditor,” laws have been passed that make any discharge of a federal student loan in bankruptcy almost impossible. You will be on the hook for guarantor loans. The moral of the story: Know your guarantor well and the consequences of default.