Understanding Personal Guarantees on Business Loans
- Most small business loans require a personal guarantee from anyone who owns 20% or more of the business.
- Personal guarantees are usually provided as additional collateral for the lender in addition to other collateral.
- If the business subsequently defaults on the loan, anyone who has signed a personal guarantee can be held liable for the remaining balance.
- This article is for small business owners who are considering personally securing a business loan.
A personal guarantee is when a business owner agrees to pay off a loan balance, even if the business later defaults. When a person personally guarantees a loan and the loan is in default, the lender can sue them and hold them personally liable for any outstanding loan balances after foreclosure and sale of any specific collateral securing the loan.
The vast majority of small business loans require a personal guarantee from anyone who owns 20% or more of the business. It is essential that business owners – even minority owners – understand how collateral works, as their personal financial future may be at stake.
Advice: If you’re wondering if you’ll need a business loan for your new business, determine how much money you need to cover start-up costs by assessing the types of costs you’ll face and projecting your flow. cash.
What is a personal guarantee?
A personal guarantee is a document that a borrower signs by committing to repay the balance of a loan in the event of default or if the property securing their loan loses value. Personal guarantees can be used for business or personal loans; but in either case, these guarantees create a broader liability for borrowers and co-signers to repay the loans.
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In some cases, a personal guarantee may be the only collateral borrowers provide for certain types of loans, such as credit cards and personal loans. Most often, personal guarantees are provided as additional collateral for business loans – including SBA loans – in addition to property securing a loan.
Loans that include personal guarantees are different from loans that do not – called non-recourse loans. Non-recourse loans do not require any type of personal guarantee, limited or unlimited, from a borrower or co-signer. If your business defaults on a non-recourse loan, the lender can’t come after you or your assets. All the lender can do is grab the collateral securing the loan and sell it to get as much money back as possible.
Personal guarantees provide another way for a lender to get their money back if your business doesn’t pay off their loan. While this reduces the risk of a loan for lenders, it increases the risk for borrowers.
Advice: To avoid defaulting on your business loan, manage your business finances carefully by having a good billing strategy, monitoring your books, and practicing good financial habits.
How do personal guarantees for business loans work?
When choosing a small business loan for your business, in general, everyone who owns at least 20% of your business should be included in the loan application and provide a personal guarantee for at least part of the loan. These guarantees are in addition to any collateral used to secure the loan.
When these personal guarantors apply for the loan, their personal credit is checked and taken into account when considering your business for the loan. If you sign a personal guarantee, you are personally responsible for the loan balance – or part of it.
If your business subsequently defaults on the loan, anyone who signed the personal guarantee can be held responsible for the remaining balance, even after the lender has foreclosed on the loan collateral. The lender can sue individual business owners who have personally guaranteed the loan – if necessary – and obtain judgments for certain amounts. This may cause guarantors to have to sell other assets or have their wages garnished to repay their share of the balance.
While personal guarantees may require business owners to repay part of a business loan, these guarantees do not. not require guarantors to put money in escrow or deposit money before guaranteeing a loan. Signing a guarantee only means that you can be held liable – either for a specific amount or up to the outstanding loan balance – if the company defaults, but no class action takes place until what a fault occurs.
What is required for a personal guarantee?
Signing a personal guarantee can greatly increase your liability when obtaining a loan, but the process of providing one is actually very simple. If a personal guarantee is required for a loan, it is usually built into the loan process. Here are the steps to provide a personal guarantee:
- To apply. Fill out a complete loan application and provide all personally identifiable information.
- Gather documents. Provide your personal financial information for review, including any interests outside of the business applying for the loan.
- Examine the records. You may need to review the financial records of any outside business interests.
- Check your credit. Perform a physical or indirect credit check.
- Implement. Negotiate a limited or unlimited personal guarantee.
- Sign. Sign all loan documents, including lien and guarantee agreements.
Regardless of what type of business loan you are applying for, the lender will guide all of the necessary guarantors through the underwriting and signing process. Borrowers will not have to do anything special other than providing information when requested and signing the required documents.
Advice: If you’re looking for a business loan, read our reviews of the best business loans and financing options, which cover conventional loans, SBA loans, and alternative lenders.
Types of personal guarantees
There are two types of personal guarantees: limited and unlimited. Limited personal guarantees require signatories to guarantee a portion of a business loan up to a specified amount, while unlimited guarantees do not have a stated limit. With an unlimited personal guarantee, the guarantors are responsible for any part of the loan balance that is not paid after the lender has auctioned other collateral securing the loan.
In many cases, lenders will add these items to the outstanding loan balance, and personal guarantors can also be held responsible:
- Increased interest
- Late fees and penalties
- Attorney fees
- Court costs
To remember : With unlimited collateral, the lender can sue the guarantors for the amount of any outstanding loan balance (plus other fees). With a limited warranty, the guarantors are only liable up to their specified warranty amount.
Personal guarantees and credit scores
Before signing a personal guarantee on a business loan, you will first need to complete a loan application process that includes a personal credit check – whether strict or not. These credit checks are generally required for all business owners who own at least 20% of your business.
A credit check can actually hurt a potential guarantor’s credit, as it counts as an impact on their credit rating. And, if your business ultimately concludes the loan and the guarantor signs a guarantee, the loan will appear on their credit report.
If a person providing the personal collateral does not have good credit, this can also impact your ability to acquire the loan – much the same as if your business did not have sufficient collateral or did not show. strong cash flow strategies – to cover eventual payouts.
Personal guarantees risks
Personal guarantees greatly increase the risks for borrowers beyond being held liable for the loan in the event of a business default. Guarantors may suffer credit damage or be unable to secure a personal loan, including a mortgage.
Here are some specific risks associated with signing a personal guarantee for a business loan:
- A guarantor’s personal credit score can be affected.
- A guarantee could have an impact on the ability of the guarantor to obtain a personal loan later.
- A guarantor’s credit can suffer even more if your business defaults on its loan.
- Guarantors can be sued and must pay attorney fees and court costs.
- You may need to sell personal property to fulfill the warranty.
- Wages can be garnished if the guarantors cannot fulfill their guarantee.
- Guarantors may have to file for bankruptcy if they cannot cover the debt.
Despite the risks, providing a personal guarantee is often the only way to get a small business loan and raise the financing your business needs. If you are determined to avoid personal guarantees, you may need to consider other financing options, such as crowdfunding and microloans.
Aside from credit cards, personal loans used for business – and some loans tied to specific assets, such as equipment or real estate – most business loans require personal guarantees of 20% or more of the money. business owners.
Did you know? Before signing a loan document, it is essential to understand the important terms of the loan agreement, such as reporting requirements, debt service coverage ratio, and prepayment penalties.
Should you sign a personal guarantee for a business loan?
If you own 20% or more of a small business and are trying to get a small business loan, you will likely need to sign a personal guarantee. That’s why small business owners need to understand how personal guarantees work and have business partners and managers they can trust.
After all, if you sign a personal guarantee on a loan and the proceeds are misused or misappropriated, you can still be held responsible for the full value of the loan – plus fees, interest, and penalties.
If a business reaches a certain size, a personal guarantee may not be required. However, signing a personal guarantee can still give a business significantly better terms or a lower interest rate, which makes it a good decision. But if signing a guarantee does not improving the terms of your loan offer, so signing a guarantee and increasing your liability may not be a wise choice.