Guarantee and guarantor are commonly used in banking, especially when seeking loans. When purchasing your home equipment you often also ask for warranties or guarantees on the products.
Many people confuse between a guarantee and a guarantor and often use the words interchangeably. We are going to explain the differences between the two terms. Let’s dive into it!
Who is a Guarantee?
Shopkeepers always give you their word when you are buying from them. They convince you of the product’s quality and durability, and more often than not, you end up making the purchase. Trust leads you to buy. Unfortunately, in today’s world, you can’t know who to trust and who not to; that is why we use a written binding agreement. It is what is known as the guarantee.
A guarantee is a promise by the seller about the quality and durability of a particular product. He agrees to replace the product with a functioning one in case of defects, as long as the guarantee period is active.
In financial institutions, a guarantee is a promise by a person or company to take the financial responsibilities of another person or company if they fail to do so. Guarantees help enhance your credit score and offer a cushion to the banks as they will get their money back if the principal borrower fails to pay it back. The document is legal and binds the person giving the promise into a contract.
Who is a Guarantor?
The person who enters into such an agreement is known as the guarantor. You become a guarantor when you accept to pay someone else’s loans if he defaults. For example, banks ask for a guarantor when the borrower’s credit score is bad or when the assets you have provided are insufficient to cover the loan amount applied. This way, they are assured that you will pay their money in case of a default. Loans guaranteed by guarantors are called guaranteed loans. Examples of such loans are the instant guarantor loans and the low apr guarantor loans.
The contract of guarantee is separate from the principal borrower’s agreement. The guarantor’s obligation comes in only when the borrower defaults to pay the loan. Before which the borrower must make the payments. Financial institutions treat guarantees as secondary agreements.
A guarantee can either be limited or unlimited. A limited guarantee means that the guarantor covers the total amount of the loan. For an unlimited guarantee, the guarantor covers a portion of the loan.
Advantages of Guarantees
- Lenders are more willing to lend to individuals with low credit scores because the guarantors offer additional protection to the loan.
- For those with no or poor financial history, guaranteed loans provide them with a chance to obtain loans which they would otherwise not have had.
- You have a comprehensive option to choose from since the guarantor can either be an individual, company, or financial institution.
Types of Guarantees
The most common types of guarantees are the following;
- Personal guarantee: A personal guarantee is a promise to repay loans that an individual makes on behalf of another individual or organization. These individuals must have good credit scores to qualify as guarantors.
The guarantor can pledge their assets that the lender will use to repay the loan if the borrower defaults payments.
- Bank guarantee: It is a promise by a commercial bank to cover the liabilities of a debtor if you fail to fulfil his contractual obligations with another party. Companies that do business with unfamiliar parties use it.
- Financial Guarantee: It is a form of bank guarantee. It is an obligation of a specialized insurance company to repay the remaining interest payments and principal amount of a bond or similar financial instrument to the lender if the borrower defaults.
Rights of a Guarantor
Because of the risks that guarantors face, they have the following rights;
- Right to information about the credit contracts and the guarantee. You should request a copy of the same and should be well conversant with the arrangements.
- You have a right to be notified in case of changes in the loan contract because you are exposed to considerable risks if it changes without your knowledge.
- You have a right to be notified if the principal borrower defaults to give you time to pursue them or make arrangements to make the payments.
- Right to subrogation. As a guarantor, you have the right to recover your money from the principal borrower if you made payments due to default. In this case, you become his creditor.
- You have the right to know the percentage of the liabilities that you guarantee. Some loans have more than one guarantor, so it is critical to know your liabilities.
Guarantees have opened borrowing avenues to those with tainted credit scores who would otherwise not qualify for loans. However, it requires good faith from all the parties involved. As the principal borrower, use this opportunity to build your credit score for the future. As a guarantor, you have much to lose; make sure you have a clear understanding of your obligation under that guarantee. Finally, be very careful before you enter into such an agreement. Seek help, guidance, and advice from a financial adviser before you sign on that guarantee.