Should Business Owners Take Out Unsecured Guarantor Loans?
Unsecured guarantor loans provide a path for borrowers with limited or poor credit histories. However, to qualify, you’ll need to find a guarantor to back the loan.
In this post, we’ll explain what these loans are, so you can fully understand this loan program.
What Is an Unsecured Loan?
To understand this type of financing, we need to explain what an unsecured loan is.
Every loan that exists is either secured or unsecured. A secured loan is one that requires collateral, which can be just about anything of value, including:
On a secured loan, if the borrower can’t make their payments, the lender can seize the collateral.
If you take out an unsecured loan, the business lender can’t seize your assets. However, they can still submit your account to collections and sue you to recoup the debt.
Since there’s no collateral to “secure” an unsecured loan, there’s more risk for the lender. All they can rely on is your credit history. As a result, unsecured loans are typically more expensive.
In addition, because unsecured loans consider your credit history, lenders are less likely to approve a borrower with poor credit history. However, a guarantor can change that.
What Does Guarantor Mean?
A guarantor is someone who supports a borrower and agrees to be financially liable in the event of nonpayment.
This individual can be a partner, friend, or family member. Your business or someone else’s could also be considered a guarantor.
Guarantors must meet the following criteria:
- Have strong credit
- Financial stability
- Be at least 21 years old
Essentially, this person agrees to be held liable if the borrower doesn’t pay. As a result, they lender won’t charge higher rates to compensate for the primary borrower’s risk profile.
A guarantor can also help someone who has a low salary, few assets, or is otherwise financially unstable. While credit history is a critical factor in obtaining an unsecured loan, salary and assets matter too.
It’s also worth noting that a guarantor doesn’t have to be involved for the duration of the loan. Often, they’ll terminate their obligation after a prespecified term.
Putting It All Together: How to Guarantor Loans Work?
Essentially, an unsecured guarantor loan is a type of loan that:
- Isn’t secured by collateral.
- Has been guaranteed by someone with financial stability.
Any loan that meets these two constraints is an unsecured guarantor loan; but your options will still vary.
For example, not all guarantees are the same. One person might guarantee the entire loan, while another might only guarantee a portion of the loan. Assuming all else is equal, pursuing a partially guaranteed unsecured guarantor loan is riskier than if it’s fully guaranteed.
Due to this, the partially guaranteed loan will be typically more expensive since the lender must compensate for the additional risk.
It’s important to note that having a co-signer doesn’t make it a guarantor loan. Co-signers have different rights and financial responsibilities than guarantors.
For example, the guarantor is only financially liable once the lender has exhausted all collection methods against the primary borrower. Conversely, a co-signer is treated like a second borrower in the event of nonpayment.
Similarly, if the loan is secured by collateral, it would be considered a secured guarantor loan.
Consumer Demographic Considerations
Determining if this loan program is a good fit for you depends on the type of consumer you are. Generally, these loans are meant for anyone who can’t qualify for traditional financing.
For example, people with poor credit usually benefit from an unsecured guarantor loan. They may have tried to secure funding options such as payday loans. However, pursuing an unsecured guarantor loan doesn’t necessarily mean that you’re financially unstable.
For example, immigrants and young people may not have had the opportunity to build their credit files. Although they may have savings and a solid income, they may struggle to qualify for traditional financing. With an unsecured guarantor loan, they can receive financing that they otherwise wouldn’t be able to qualify for.
For someone who could get approved for traditional financing, unsecured guarantor loans aren’t beneficial. This is because that person will likely get approved for a loan with comparable (or better) rates and larger loan amounts. In addition, they wouldn’t have to take time to find a guarantor.
Advantages of Unsecured Guarantor Loans
1. Less Strict Prerequisites
Provided you have a guarantor with a high credit score, your credit history won’t be too important to the lender.
2. Competitive Pricing
As mentioned, having a guaranteed loan reduces risk for the lender. In turn, the overall price of the loan will decrease. Compared to other financing options for borrowers with bad credit, unsecured guarantor loans are competitively priced.
3. Larger Loan Amounts
The relatively lower risk profile of a guarantor loan helps borrowers qualify for larger loan amounts.
4. No Need for Collateral
Instead of requiring collateral, the lender holds the guarantor’s credit score as proof that the loan will be repaid. If you don’t have assets or don’t want to risk losing them, finding a guarantor may be your best option.
Potential Downsides of Unsecured Guarantor Loans
1. Potential Negative Impacts on Your Relationship with the Guarantor
When someone guarantees a loan for you, your financial fate is intertwined. If you’re unable to pay off your loan, this can cause tension.
2. Risks to the Guarantor
If the borrower doesn’t repay the loan, the guarantor must make up the difference. In addition, just as the default will affect your credit score, it will show up on the guarantor’s credit report. If they don’t want to risk their strong credit rating, being a guarantor may not be worth the risk.
3. The Borrower Must Divulge Private Details
Depending on the guarantor, they may want to confirm that you can pay back the loan on-time. For many borrowers, divulging this private information can be uncomfortable.
4. Interest Rates Can be High
These loans are more affordable than some financing options available to borrowers with low credit. However, that doesn’t mean they’re more affordable than traditional financing options, like a secured business loan.
These loans are typically best suited for borrowers with poor credit histories. Therefore, if you’re seeking this type of loan, assume that any alternatives should have lenient credit score requirements too. Financing alternatives include:
- Merchant Cash Advances: Your credit card sales are used to determine if you qualify.
- Invoice Factoring: Your business invoices will determine if you qualify.
- Equipment Financing: Your credit score may matter but the score requirement is usually not high.
From a financial perspective, unsecured guarantor loans are an attractive option if your credit isn’t perfect.
However, there are non-financial factors to consider. If you’re unable to pay, your guarantor can be held legally responsible, which could damage your relationship with them.
Still, that doesn’t mean that this loan option isn’t worth considering if your business requires additional financing. Instead, it means that you and your guarantor must be aware of the risks prior to signing a loan agreement.
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Editor’s Note: This post was updated for accuracy and comprehensiveness in October 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.