The word Guarantee is defined by the Oxford Dictionary of English as “An undertaking to answer for the payment or performance of another person’s debt or obligations in the event of default by the person primarily responsible for it”.
Understanding What it Means to Be a Guarantor
There are many misconceptions about what guaranteeing a loan means. It’s important you know exactly what you’re going into before before you sign as a guarantor..
- Guarantee is not a character reference – As a guarantor, you have provided confidence to the lender of repayment of the loan. If the borrower does not make the required payments, you must make them. You will also be responsible for paying any interest or fees, including costs of recovery of the loan and other legal fees in the event of recovery.
- Another misconception is that the lender will pursue the borrower for repayment first – That is not true. If the borrower stops making loan payments, lender can collect the debt from you without trying to get it from the primary borrower first. They can pay in your post-dated-cheques without notice or take you to court to get repayment of the debt. Many lenders don’t alert the guarantor until the loan is in default, which can significantly increase the amount you owe through interest and fees.
- If the borrower declares bankruptcy, the debt is still not forgiven – Not true, even if the court discharges a debt for the borrower, you are still responsible for paying the full amount of the debt plus any interest and fees unless you also declare bankruptcy.
Before you provide guarantee on a loan, think carefully about the risks and what the loan can do to your finances.. It’s not just about helping someone out, it’s about your own financial wellbeing too.
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Loan Guarantee can be of 2 types.
1. Loan Guaranteed for an individual.
2. Loan Guaranteed for a corporate.
Loan Guarantee for an Individual
A person providing guarantee for a loan taken by an individual must have met certain criteria specified by the lender. The lender in most cases are Micro Finance Lenders that does not have hold on the salaries or other assets of the borrower, but will required another individual that meet specified criteria to provide additional comfort for the loan.
A family member or friend may ask you to guarantee a loan especially if they’re borrowing from a Micro Finance Bank. Before you agree, it’s important to understand how much he or she is borrowing and what your responsibilities are as a guarantor.
Loan Guarantee for a corporate
There are 3 different ways to provide guarantee a loan taken by a company:
1. Guarantee by one person
2. Guarantee by two or more persons
3. Guarantee by a limited liability company
Guarantee by one person – It is only in the case of a sole proprietorship business that an individual can provide guarantee for a company. Although the law does not recognize/provide any distinction between a sole proprietorship business and the owner, most banks still require personal guarantee of the prime mover of an enterprise to be provide before a loan is disbursed to the company.
Such guarantee is always accompanied with notarized statement of net worth of the prime mover. The essence of the statement is to be sure that the prime mover/s has some worth or value that the bank can fall-back-on in the event of default of the primary obligor which in this case is the company/business. The statement is notarized in other to give legal backing to it.
Most banks will required the guarantee for both secured and unsecured loans except for cash backed facilities and the guarantee is the final fall back option for the bank in the event of default.
Guarantee by 2 or more persons – This type of quarantine is required for a limited liability company as a final fall back option for the bank in the event of default of the primary obligor which in this case is the company. The directors of the company are expected to provide the guarantee.
Most banks will require all the directors listed in the Corporate Affairs Commission (CAC) company registration documents to sign as guarantor for the facility while some will exempt shareholder with less than 5% share holdings. The directors are also expected to provide notarized statement of net worth as guarantors of the facility.
Lenders will require the guarantee for both secured and unsecured facilities and the guarantee remains the final fall back options for banks in the event of default of the primary obligor and the security/collateral for the facility is not easily realizable.
Guarantee by a limited liability company – This form of guarantee is provided by a company to either secure a loan for another company or to secure a loan for its employees.
A company providing guarantee for another company is assuring the lender that if the primary obligor fails to fulfill its loan obligations, it is willing to take over the responsibility. The company provides its audited statement and its cash flow to the bank to prove its ability to accommodate the facility in the event of default. .
Most short tenured loans like Auto Loan; Personal Loan, Asset Acquisition Loans and Mortgages Loans granted by banks to staff of companies comes with the corporate guarantee of the company. The company guarantee is often times limited to their commitment to continue to domicile the salary of their staff to the bank that granted the facility until the facility is liquidated and to pay their employees terminal benefits to the bank if the employee resigns or quit his or her job before the facility is fully liquidated.
This however may not be applicable to companies that are not well structured that the bank has granted loan facilities to its staff. Corporate guarantee of such companies goes beyond salary domiciliation and terminal benefits. Such company will have to provide/liquidate the facility if the terminal benefit of its staff is not enough to pay off the facility.
It is important to note however that although guarantees are seen as the final fall back option for bank facilities. The bank reserve the right to call in the guarantees if it is seen as a quick way out of the delinquent loan facility.
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