If you don’t have an asset or deposit to put up for a business loan, you could opt for a guarantor business loan. With a guarantor, you increase your chances of getting the loan and how much you can borrow. You may also be offered a lower interest rate.
What is a guarantor business loan?
A guarantor business loan is where your business loan is secured by someone else. They essentially guarantee that the loan will be repaid even if you don’t meet your payments.
You can apply for a business loan with a guarantor if you’re unable to provide an asset as security, or if you don’t have enough of a deposit to put down for the loan. The guarantor will provide one of their own assets as collateral, and agree to repay the loan in case you can’t. With someone else guaranteeing repayments, it reduces the lender’s risk of lending and increases your chances of getting a loan.
With the exception of having someone else guarantee your loan, it is essentially the same as other business loans. This means that your loan will have the same features as other business loans. This can include features like redraw facilities.
Why do I need a guarantor business loan?
Banks and lenders are risk-averse. They want to be certain that the loan conditions will be upheld and the loan will be repaid in full and on time.
For this reason, lenders typically require some form of security for a business loan. With security, the lender has a means to recover their investment in case you default. It also shows that you, as the borrower, are personally committed to the business and the loan agreement.
If you don’t have sufficient means of securing the loan, but can otherwise meet the ongoing loan repayments, lenders will consider a third-party guarantor. This arrangement brings another person into the loan agreement. Your guarantor will be someone vouching for your ability to meet the loan repayments. They are also willing to put up their own residential property as security should you default.
Who can act as a guarantor for a business loan?
With home loans, lenders typically require a guarantor to be your parents or close family members. But this is not the case with a business loan. Your business partner or other interested party can act as guarantor for the loan. The person you choose must have a legitimate interest in the business or have a sufficiently close relationship with you. They must also have sufficient assets to guarantee the loan.
What can a guarantor offer as security?
Generally, a guarantor will have to offer residential property as security. In some instances, a lender may consider commercial property such as a warehouse, office or factory as security. Highly specialised commercial property, such as a fully fitted-out dental practice, or childcare centre, will require ongoing valuations by the lender. This is because the value of specialised commercial property can fluctuate significantly, especially compared to the relative stability of residential property. They may, therefore, be considered less desirable than residential property.
How much of the loan is the guarantor securing?
Unlike a home loan, the guarantor for a business loan can secure the entire loan. This is because a loan to purchase or start a business doesn’t have tangible assets the lender can use as security for part of the loan amount. Given how high the risk is for the guarantor, both you and the guarantor need to be clear on the value of the loan they are guaranteeing.
Pros and cons of loans backed by a guarantor
Pros
You have a higher chance of approval.
It increases the amount you can borrow.
You may receive interest rate discounts.
You’re limiting your own liability should the business fail.
Cons
You’re getting into debt, while your guarantor is taking the risk. They could lose their property if you fail to repay the loan.
You may be putting your relationship on the line.
How much can I borrow with a guarantor business loan?
This will depend on the value of the property used as security. For residential property valued up to $1 million, you can borrow up to 80% of the equity in the property. For properties valued over $1 million, this rate generally drops to 70%. It is important to keep in mind that your income needs to be sufficient to service your loan repayments, even if you have a guarantor. The lender will not allow you to borrow more than you can comfortably repay, no matter the financial status of your guarantor.
As a guarantor, what are the risks of a guarantor business loan?
If you want to act as someone’s guarantor, it is not a decision you should take lightly. It’s important you understand all the risks involved, especially as you’re ultimately responsible if the borrower defaults. Here are some of the risks you should consider:
You’re taking a financial risk. If the borrower fails to repay the loan, you may have to pay back the entire or remaining debt. Your asset could be repossessed to pay for the loan. If the debt exceeds the proceeds from the sale of the asset, you will have to pay that too.
You may not be able to get a loan. You cannot use your asset as security for another loan. In case you wish to apply for a loan, you will not be able to use the same asset as you use to secure a guarantor personal loan. This means that you may not be able to get a loan. You will also have to mention your role as guarantor in your loan applications. Lenders will treat it as your liability.
Your credit score could be affected. As much as your credit score can strengthen the borrower's application, any defaults will affect your credit score. The loan application will appear in your credit file, as will any defaults.
You could damage your relationship with the borrower. This should also be considered in your decision making process.
Your legal obligations will remain even if your relationship to the borrower changes. Even if your relationship with the borrower changes, you will still be obliged by the terms of the loan. You can be removed as the guarantor, but there are certain conditions. It will have to be before the lender loans the money, or if there is a discrepancy with the loan agreement and it’s not what you initially signed up for. If it’s during the loan period, you may have to pay what is owed anyway, pay the maximum agreed amount or suggest another agreement. You can seek free legal advice before agreeing to be the guarantor.
What are the alternatives to a guarantor business loan?
If you don’t have security or a guarantor, there are other business loans you can apply for. This includes:
Unsecured business loans. With this type of loan, you don’t need security but you will need good credit. Lending amounts are typically lower and interest rates are higher.
Low doc business loans. These business loans don’t require extensive documentation. This is useful if you don’t have much of a business credit history, or you have bad credit.
Risk-based business loans. Many alternative lenders, including peer-to-peer lenders, offer risk based financing. Your credit score will play a role in that it determines your interest rate. The better the score, the lower the rate and vice versa.
Invoice financing. If you have many unpaid business invoices, you could get a loan against them. You’re basically converting your unpaid invoices into cash. No real estate is required as your invoices act as security.
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Stacey Cole has degrees in law and science, but happily left the busy world of litigation to be a full-time mother and writer. In her spare time she loves travel, roller coasters, and old-school gaming, even if her daughter can already beat her at most games.
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