Key Takeaways
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Definition
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A personal guarantee is a commitment made by a director to repay a loan in the event that the business itself can’t do so. In case the business defaults on the loan, the guarantor/s will be responsible for paying the loan instead.
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Purpose
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Personal guarantees reduce the risk for lenders, especially when they’re approving loans for newer businesses or those without a strong credit history.
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How it Works
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Once a business defaults on a loan, the lender will first try to recoup losses from the business itself. However, if the funds aren’t enough, they will recover the funds through the guarantor.
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Spousal Guarantees
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Another way for lenders to protect themselves is through a spousal guarantee, which holds the business owner’s spouse liable to repay the loan in the case of default. This is used when personal assets like the family home are jointly owned or owned solely by the spouse.
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Lenders take on risk whenever they approve business loans. That’s why borrowers go through an approval process where they demonstrate their capacity to repay loans through their finances, credit history, and security. Lenders want to ensure that the loan will be repaid and that they will not incur big losses. One way for lenders to mitigate the risk related to lending is through the requirement of personal guarantees.
What are Personal Guarantees?
A personal guarantee is a legal commitment made by a business owner to repay a business loan personally if the business itself cannot make the payments. This guarantee effectively makes the individual responsible for the loan together with the business.
Purpose
The primary purpose of a personal guarantee is to reduce the risk for lenders when approving a loan, especially to businesses that are new or those that may not have a strong credit history. By having a personal guarantee, the lender has an additional layer of security, knowing that if the business defaults, there is another way for them to recoup losses.How It Works
- Risk to Personal Assets: By signing a guarantee, directors agree to be personally liable for the loan amount should their business not be able to make repayments. This can impact the director’s savings, investments, real estate, and other valuable assets.
- Legal Process: If the business defaults on the loan, the lender will first attempt to recover funds from the business itself. If the funds are insufficient, the lender can then turn to the personal assets of the guarantor/s.
Spousal Guarantee
Lenders can also protect their interests through spousal guarantees. A spousal guarantee is a legal agreement where the spouse of a business owner agrees to become liable for the repayment of the loan if the business defaults. This type of guarantee is often used when certain personal assets (family homes, vehicles, and other properties) are jointly owned by both spouses or solely owned by the spouse. Spousal guarantees help lenders mitigate risk by broadening their access to more assets in the event of a loan default.
