By Justin Pritchard. Banking/Loans Expert
Justin Pritchard helps consumers navigate the world of banking.
When businesses borrow money, banks sometimes require a personal guarantee from the business owner (or other key individuals in the business). Ideally, the business would borrow on its own - without involving anybody's personal assets - but sometimes that's not an option.
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Personal Guarantee Basics
Lenders always evaluate borrowers to predict whether or not they'll repay. For consumer loans, there are credit scores and numerous other sources of information to help with the decision. However, businesses - especially new businesses and operations that have never borrowed - probably don't have a business-specific credit history.
With limited information it’s hard for lenders to make a decision. They would be more comfortable if they could see that you've borrowed money in the past and consistently repaid loans.
When they can't make a decision based on historical information, they require some sort of security (or they charge an extremely high interest rate). That security often comes in the form of a personal guarantee, although other approaches such as pledging business assets as collateral. can be used.
With a personal guarantee, the business owners (or whoever else guaranteed the loan) sign an agreement saying they are personally responsible for repayment. Even if the business is incorporated to
limit personal liability, you are personally tied to any loan you've made a personal guarantee on.
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Without a personal guarantee, many small businesses simply can’t get loans. Banks want to improve their chances of getting paid, and they know that businesses fail all the time. Lenders want to have options: they want to be able to collect no matter what happens to your business. They may also wonder why they should take a risk if you as a business owner are not willing to put skin in the game.
What's the Risk?
When you provide a personal guarantee, you allow a lender to pursue you personally if you can’t repay a business loan. That can mean different things, depending on your loan agreement. As part of the guarantee, you might have given the bank permission to take assets such as property you own (including your home or certain valuables) or investment accounts.
It's also likely that lenders can take legal action against you, which would damage your credit and make it difficult to borrow in the future (not to mention potential hurdles for getting a job, buying insurances, or renting a place to live).
If you’re considering a personal guarantee, learn more about the risks. Also, remember to negotiate and try to protect yourself as you make the guarantee.
Category: Payday loans