Sometimes the only way to push a loan to approval is to back it up with your own money. This is called a loan guarantee. It is common in business transactions and when a primary borrower can’t qualify on his own. Essentially, you will promise repayment of, or guarantee, the loan in the event a primary borrower won’t pay.
Reasons for Guarantee
Loans are made largely according to the borrower's capacity to repay. Sometimes, the borrower is not strong enough on his own. One common example is a start-up business. On a business loan, the borrower is the business itself. Since the business is new and may not have much profit, the owner will guarantee the loan using his own money. Another example is an auto loan. A teenager buys her first car, but can't afford the payments with only a part-time job, so her father uses his income to guarantee the loan.
The guarantor's responsibility is to pay the loan in the event the primary borrower does not. There are two types of guarantees. An unlimited guarantee means the guarantor is responsible for the full amount of the loan no matter the circumstances. A limited guarantee means the guarantor is only responsible for a portion of the loan. For example, a 20 percent owner in a company provides a guarantee on a business loan. Since he only owns 20 percent of the company, he only guarantees 20 percent of the loan. This means on a $200,000 loan, he is responsible for $40,000.
A guarantee is made official by a guarantee document. This document outlines the term of the loan and the guarantor's responsibility. If the guarantee is limited to a portion of the loan, it is spelled out here. The document details the circumstances under which he is responsible for the loan. It also lists the ways the bank can go after him such as demand letters, asset seizure or bank levys. Often a guarantor will have to provide yearly financial information so the lender can determine that the guarantee remains strong. If so, this will be outlined in the document as well.
Release of Guarantee
At some point a guarantee may not be good or even needed anymore. At this point, the guarantee will be released. The provisions for release of a guarantor are outlined in the initial document. The most common scenario for releasing a guarantor is when a partner leaves a business. The lender will mark his guarantee as released, but will usually require any new partners to provide a similar guarantee. If the partner leaves without replacement, the others will be responsible for his portion if their guarantees are unlimited. If not, they will have to provide new guarantees for the revised percentage of ownership.