What is a Personal Guarantee?
A Personal Guarantee is like an agreement between three parties – lender, borrower and guarantor, whereby the guarantor agrees or promises, and has legal binding attached to him, to repay the lender and honor the loan agreement in case of default made by the borrower, irrespective of the fact that the person giving guarantee is or is not attached to the business for which the loan is taken.
In simple words, the guarantee means providing security.
- When talking about a personal guarantee, it refers to the promise made by a person to honour the agreement and accept and make the payment of the liability and obligations as agreed in the agreement. Personal assets of the guarantor, may or may not be attached, the same may be decided at the time of getting into the arrangement.
- The personal guarantor makes this legal promise to the lender, in order to support the borrower to help him get the loan or debt.
- In an event of default by the borrower, the lender may make a claim to the personal guarantor to make good the default.
Purpose of Personal Guarantee
- The purpose is to ensure that the promises made in an agreement are performed.
- When such a guarantee is given, the person is personally responsible (i.e. in his personal capacity which means attaching his personal assets) to fulfil the promise and compensate the lender, in case the borrower ends up making any default on his part of the promise.
- The lender should have tried all ways to recover the debt from the borrower first, only then can he go to a personal guarantor.
- It’s a conditional promise i.e. only in the event that a borrower defaults, the lender may resort to recover the dues from you.
- There should a balance of debt/liability which is pending repayment.
#1 – Limited Guarantee
- In an agreement where there are multiple owners/partners, each of them shall have a fixed percentage of holding in the business.
- Accordingly, each guarantor shall be obligated to honour only to the extent of such a fixed amount of liability in case the business defaults.
- Going deeper, limited guarantee can be either (i) several guarantee or (ii) joint and several guarantees.
- A several guarantee means that your obligation, to repay the balance debt, is restricted strictly to the extent as mentioned in the loan agreement.
- A joint and several guarantees mean several guarantees (as explained above) but extended with the responsibility of making full repayment of balance debt in case an owner/partner does not pay up their required portion.
#2 – Unlimited Guarantee
As the title suggests, offering an unlimited personal guarantee means that the guarantor is fully responsible for making the repayment dues in case of default by the borrower, whether or not you owe a guarantee of 100% repayment.
Why do Lenders need a Personal Guarantee?
- The main reason that lenders ask for a personal guarantee is to ensure security to the amount being lent and further it also gives them an added level of assurance and comfort that the borrower shall pay the loan amount duly on time.
- It helps them make sure that the borrowers are committed to making the repayments and shall not take any undue advantage or utilise the loan amount in any unwanted and unnecessary ways.
- For the borrower, a personal guarantee may help businesses fetch loans that may not have been possible earlier or get a bigger loan amount sanctioned.
- For the lender, this will give him an assurance that the money shall be repaid, in case of any defaults and that his money is totally secured.
- The biggest risk is that it entails is that once the same gets invoked, you are liable to fulfil the arrangement as there is a legal binding attached to it and make good the debt.
- It may be possible that you may have to use all your savings, kept aside for children, retirement, emergencies etc, and pay the dues. In case of high loan amounts, you may have to use your personal assets to pay up.
- In high-risk scenarios, bankruptcy is also possible.
- So before signing for any personal guarantee, its’ always safe to read and understand every term and liability.
- The credit history and credit rating of the guarantor is considered along with the borrowers’ credit history and rating.
- Improved/better credit backing/availability for a loan.
- Improves chances of fetching a loan for a small business which may not have been otherwise possible.
- Gives an assurance to the lender that the loan shall be repaid.
- In case the business does not grow or fail to succeed in earning the required rate of returnRequired Rate Of ReturnRequired Rate of Return (RRR), also known as Hurdle Rate, is the minimum capital amount or return that an investor expects to receive from an investment. It is determined by, Required Rate of Return = (Expected Dividend Payment/Existing Stock Price) + Dividend Growth Rate, and loan default takes place, the personal guarantor may be required to help in making the loan payments.
- Personal assets may get attached and utilised for repayment purpose.
- Credit rating may get affected when a personal guarantee is invoked and is required to pay.
- To summarize, Personal Guarantee refers to that enforceable part of an agreement having a legal binding that in an event the borrower does not fulfil his obligations towards liabilities/dues, this guarantee shall be invoked and the personal guarantor is liable to honour the agreement.
- It may be either limited or unlimited. Further, personal assets may also be attached for making repayment, if required.
This has been a guide to What is Personal Guarantee & its Definition. Here we discuss the purpose of such guarantee, features, and types along with reasons, risks, advantages, and disadvantages. You can learn more about from the following articles –