Business Case Studies

What are the risks of being a guarantor?

The consumer guarantor loan industry is worth over £400 million in the UK and thousands of customers will use a guarantor to secure their loan agreement and borrow £1,000 to £15,000. This is commonly used by customers with zero or poor credit histories and they need an extra person to be their guarantor to give the lender some peace of mind. Guarantors are usually parents, siblings, close friends or relatives and they usually have a very good credit score and agree to cover any missed repayments. However, with a lot of money at risk, this can be a huge responsibility, so understanding the risks is ke

Understanding the risks

The main risk of being a guarantor is that if the main customer defaults on a consumer product, you are required to pay the bill. The outstanding debt is not just the loan amount, but also the interest too – meaning that a £15,000 loan over 3 years could cost a total of £24,000.

The risks are that the person who is taking out the loan potentially loses their income and is unable to keep up with their repayments. This might be due to falling on hard times, losing their job or experiencing health issues which make it hard for them to maintain their current salary.

Furthermore, you might find that the person goes missing or moves country without your knowledge – and this is a possibility with someone that you do not know very well. There is also the potential loss of a relationship or falling out and how this must affect the loan agreement. Could the person purposely not pay the loan out of spite?

In the event that the main borrower dies, you will still be required to make payment on their behalf.

Being a guarantor can be a rewarding way to help someone get the finance they need if they have been turned down elsewhere. Seeing a family member or close friend thrive can be very satisfying. However, it can also be a very costly exercise.

How to overcome the risks

Before proceeding, you will be presented with a loan agreement and be approached by the guarantor lender to discuss your responsibilities and roles, explains Guarantor Loan Comparison. Typically, a guarantor does not have to do anything once the loan has been funded and the majority of guarantors will never even hear about the loan again even if it runs over 3 or 5 years. Nevertheless, it is essential to go through the terms of the agreement in detail and discuss it with the other borrower so you avoid any future confrontation.

An important question is assessing your relationship with the borrower. A parent or sibling is someone who you are always going to be in contact with, but a girlfriend or work colleague is something that you may not be speaking to in a few years’ time. Since a loan can last for up to 5 years, you do not want to receive a phone call out of the blue asking for money – even though the loan agreement seems like a distance memory. Therefore, being selective with who you act for is an essential way to mitigate risk.

A further consideration is whether you can afford to make payments on the individual’s behalf. Whilst many people have disposable income, the amount that a guarantor loan can accumulate to is sometimes well beyond the means of most people. If this is something that you cannot afford, then it might be better to stand clear.

Finally, the funds are always sent to the guarantor first as a security measure. This gives the lender peace of mind knowing that any sum of money is given to someone with a good credit rating first. The guarantor can then pass the money onto the main borrower. A method to manage finances effectively is by giving the money to the borrower in monthly instalments or over a period of time. This means that they will not be tempted to overspend and can use the money carefully. If the individual finds that they are back on their feet in a short space of time, the loan can be repaid in full and the guarantor will no longer be implicated.