Guarantor loans are loans that, rather than being secured with property or collateral, require another individual to sign an agreement stating he or she will pay the loan if the borrower defaults. This type of loan is often used when the borrower has poor credit or no credit at all. Although guarantor loans can be very beneficial to the borrower, they come with some disadvantages.
- They come with high interest rates.
When you take out a loan, the amount you have to pay back includes both the principal, which is the amount you borrowed, and the interest. Depending on where and how much you borrow, the interest can be a good portion of the amount you pay back. Since guarantor loans are often considered high risk, they often have higher interest rates than traditional secured loans.
- Your credit score will be affected.
When you take out a guarantor loan it shows up on both your credit report and the guarantor’s credit report. Prior to approving the loan, the lender will likely run a credit report on both the borrower and the guarantor. Each time an inquiry is made into someone’s credit report for the purpose of giving credit, it affects the credit scores negatively. It may not affect it heavily or for long, but it still affects it.
The length of a person’s credit history makes up 15% of their credit score. When the guarantor has a new loan on his or her credit report, it hurts their score. If the guarantor later wants to obtain credit, the guarantor loan will show up on their credit report as if they owed the money, which can affect their credit scores. Lastly, if the initial borrower defaults on the loan, it affects the guarantor’s credit scores.
- The guarantor might have to pay.
If you default on the payments of the guarantor loan the guarantor is the one who will have to make up your payments. In the case of a mortgage loan, the guarantor will have to pay the loan if the borrower doesn’t, but the property will still belong to the borrower. In situations like this, the guarantor could end up making payments for years on something he or she will never own.
- They can cause emotional and financial strife.
It can cause emotional stress between the borrower and guarantor when a borrower defaults. It can also cause additional financial stress on the guarantor because he or she is forced to pay for a loan that they never intended to pay for.
In summary, guarantor loans can be beneficial to borrowers who otherwise would not have been able to obtain a loan. However, it’s important to understand that they do come with some risks. Before obtaining a loan or asking for a guarantor, the borrower should be in a good financial state so he or she won’t have to rely on the guarantor to pay the loan.
