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Guarantor small business loans
A guarantor can help you get approved, increase the amount you can borrow and potentially reduce the interest rate of the loan.
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When you approach a lender for a business loan, one of the first questions they will ask you is whether you have a residential property to put up as security for the loan. This can make getting approved for business finance – whether to start your own business or buy an existing business – extremely difficult if you don't have sufficient equity in residential property or a large enough cash deposit.
A business loan with a guarantor is an alternative way for people to obtain business finance, especially if they don't have an appropriate residential property or a large enough deposit to secure the loan. Read on to find out how a business loan with a guarantor works, and the factors you should consider if you have been asked to be a guarantor.
Understanding business loans with a guarantor
The benefits of a guarantor
The primary benefit of having a guarantor for your business loan is that, in many instances, a guarantor arrangement can be the difference between getting approved for business finance or being turned away. Other benefits include:
- Increasing the amount you can borrow
- Limiting your own liability should the business fail
- Taking advantage of interest rate discounts should the guarantor offer residential property as security
- Mitigating the effects of a limited or bad credit history
Why would a lender ask for a guarantor?
In general, banks and other lenders are risk averse. Before approving any finance application, lenders want to be satisfied that the loan conditions will be upheld by the borrower and that the amount extended will be repaid. While lenders look at a number of criteria when deciding whether to approve a loan application, the overall question they seek to ask is whether they are confident that the loan will be repaid.
For this reason, lenders typically require some form of security over a business loan. Not only does this security give the lender a means of recovering their investment should you default on the loan, it also shows that you, as the borrower, are personally committed to the business and the loan agreement.
If the borrower does not have sufficient means of securing the loan but is otherwise able to meet the ongoing loan repayments, lenders will consider a third-party guarantor. This arrangement brings another person into the loan agreement, someone who is vouching for the ability of the applicant to meet the loan repayments and who is willing to put up their own residential premises as security should the loan conditions default.
Who can be a guarantor?
When it comes to loans for residential homes, lenders typically require that a guarantor be one or more of the applicant's parents or other close family members. However, this is generally not the case with business loans, where lenders will consider a business partner or other interested party to act as guarantor for the loan.
As long as the person has a legitimate interest in the business or a sufficiently close relationship with the loan applicant – and provided the person has sufficient assets to guarantee the loan – the lender will likely consider that person as a good candidate to be a guarantor for a secured business loan.
What can the guarantor offer as security?
Generally, a guarantor will offer residential property as security for the loan. In some circumstances, a lender will 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 and may therefore be considered less desirable than residential property. This is because the value of a highly specialised commercial property can fluctuate significantly, especially compared to the relative stability of residential property.
How much of the loan is the guarantor securing?
An important consideration to be aware of is how much of the loan the guarantor is securing. When dealing with guarantor loans for residential property, the guarantor typically only secures a portion of the loan, generally between 20% and 25% of the value of the property. Similarly, when purchasing commercial property with a guarantor, the guarantor will usually secure between 30% and 40% of the value of the property.
When it comes to a loan to purchase or start a business, the guarantor may be securing the full 100% of the value of the loan. This is because a loan to purchase or start a business does not involve a tangible asset that the lender can use as security for part of the loan amount. It is important that both you as the borrower and your potential guarantor understand the proportion of the value of the loan they are promising to guarantee.
The difference between guarantors and co-borrowers
A guarantor and co-borrower have one important similarity: they are a third-party signatory to a loan, and can often be the difference between a business application being approved or being rejected. However, the differences between a guarantor and a co-borrower are significant and important to understand.
A co-borrower:
- Is a direct borrower with the same standing as the original borrower
- Is jointly and severally liable for the loan
- Can be required to repay the loan, even if the original borrower has not been fully pursued
- Has equal rights to and interests in any property, business or other assets purchased with the loan funds
- Can have their borrowing potential negatively affected because the full amount of the debt will show on their credit record
A guarantor:
- Is not responsible for making regular loan repayments, provided the borrower does not default on the loan
- Is responsible for paying back the entirety of the loan, plus interest, fees and charges, if the borrower defaults on the loan repayments
- Does not have any rights to the property, business or anything else purchased with the loan funds
Loan terms of a business loan with a guarantor
The loan features of a business loan with guarantor
In general, a business loan with a guarantor will have the same loan features as a regular business loan. In some instances, a business loan with a guarantor will attract more favourable interest rates than an unsecured business loan, because the guarantor will generally offer residential property as security for the loan.
As with other business loans, a business loan with a guarantor can, depending on the circumstances, include an overdraft, line of credit, redraw facility and offset account.
How much can I borrow?
For residential property valued up to $1 million, up to 80% of the equity in the property can be borrowed against. For properties valued over $1 million, this rate generally drops to 70%. It is important to keep in mind that, regardless of the value of your guarantor's residential property, your income must be sufficient to service the ongoing loan repayments.
In other words, a lender will not allow you to borrow more than you can comfortably repay, regardless of the financial status of your guarantor.
From the guarantor's point of view
Understanding the risks of being a guarantor
Being a guarantor is not a decision that should be entered into lightly. If considering becoming a guarantor for someone else's business loan, it is important that you understand the risks associated with a guarantor arrangement. In particular, understand that you could potentially lose your property in the event that the business loan is defaulted.
While the most common reason for a business loan to default is if the business fails, remember that there are a number of reasons why a business could fail. Some businesses may fail due to mismanagement or even criminal activity, but in the majority of instances businesses fail for other reasons, and not necessarily through any fault of the business owner. Regardless of fault, should the borrower default on the loan repayments, as a guarantor you are liable to pay the remainder of the debt.
Make no mistake that the lender will not hesitate to recover their investment, even if this means selling your residential property. While the lender cannot take more than the amount owed, they will sell your residential property as expeditiously as possible and will return any remaining funds to you, once their loan has been satisfied in full.
A mistake that many potential guarantors make is believing that the security of the loan solely comes down to the trustworthiness of the borrower. While this is an important consideration to make, and you should refuse to guarantee a loan of a person that you do not deem to be completely trustworthy, there are also other circumstances under which the borrower could default on the loan.
For this reason, it is essential that you ask to see financial documentation and the borrower's business plan – the same information they will present to the lender during their loan application process – before entering into a loan guarantor arrangement.
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