When the economy falls on difficult times, the credit markets begin to have issues. While the need for credit increases for individuals trying to navigate market conditions, lenders tend to become more conservative with their lending practices. It is in this kind of credit environment that different kinds of loans move to the forefront. Lenders start asking for co-borrowers, co-signers, and guarantors so they have more protection from individuals with marginal credit worthiness.
What Are Guarantor Loans?
Guarantor loans are loans that require a guarantor to sign the loan along with the original borrower. This type of loan is typically unsecured and forces the lender to seek further assurance that the loan will be repaid. The guarantor promises to repay the loan balance should the original borrower default on the required payments. It is important to note that guarantor loans offer lenders more flexibility when determining interest rates and they often carry higher interest rates due to the original borrower’s credit issues.
How Do Guarantor Loans Work?
When an individual submits a loan application, their credit background is investigated. If the lender finds their credit to be insufficient for any reason, they may choose to offer loan approval if the borrower can find an adequate guarantor to co-sign the loan agreement on their behalf. In lieu of good credit from the initial borrower, the lender will use the good faith credit of the guarantor as the basis for approving the loan.
Common Types of Loan Guarantors
Essentially, anyone is eligible to co-sign as a guarantor as long as their credit is in good shape.
- Friends and Relatives
Most people in need of a guarantor will first ask a friend or relative to guarantee the loan. While these friends and relatives may be willing to step in and co-sign, they will need to understand the possible ramifications. In case of default or late payments, the credit rating of both the borrower and the guarantor could be affected. Also, by guaranteeing the loan, the guarantor's debt-to-equity ratio will be affected, which might affect their ability to obtain more credit.
- Government Guarantors
In this day and age, many young adults are in need of student loans to help handle the rising costs of tuition and books. Since students tend to have no credit, they often turn to the federal government to act as loan guarantors on their loans. The Federal Stafford Loan program is a good example of this type of loan. There are also government agencies that guarantee home loans for first time home buyers. From a lending standpoint, loans guaranteed by the federal government are very attractive.
The reality is that guarantor loans have become more popular in most recent years. As long as all parties understand the effects of lending/borrowing on this type of agreement, guarantor loans are a great alternative for individuals with poor or no credit.