If you’ve approached a bank for a small business loan, does being a guarantor affect your credit score may have crossed your mind. There’s no doubt they’ve requested your commitment to back the loan or line of credit in the event the business fails. Personal guarantees are becoming a standard practice for many lenders and lending partners.
Even the Small Business Administration requires owners who hold at least 20 percent of the company to guarantee the loan. Before you jump the gun in excitement, you should know what you’re agreeing to as a guarantor. This guide will explain possible outcomes of signing a personal guarantee and does being a guarantor affect your credit score.
Simply put, a personal guarantor is the business owner or officer who signs an unsecured document guaranteeing repayment of funding if the company fails to pay. It’s like acting as your company’s co-signer. In majority of cases, the guarantor is an owner or officer with significant interest in the company. They will hold all, most, or a large portion of ownership of the business.
Lenders will seek a personal guarantee from theses parties for numerous reasons. The primary reason, as I explained above, is to secure repayment of the loan. Financial institutions also want to see how confident you are in your business and if you’re fully committed. Spouses may be part of the personal guarantee process when household finances are tied to the business.
The consequences of your business falling behind on loan or line of credit payment vary. It depends on the type of personal guarantee you signed. Knowing which personal guarantee you’re on the hook for can better explain does being a guarantor affect your credit score.
The two types of personal guarantees are:
Attorney Barbara Weltman explains that a guarantee of collection requires lenders to go through a legal process. They must do this before accessing a delinquent debtors assets to satisfy debts. Reporting negative activity on the guarantor’s credit requires the same procedure.
The guarantee of payment is almost immediate. It doesn’t require any filing, court order, or lengthy collection process to go after personal assets. If the contract doesn’t specify, assume you’re signing a guarantee of payment.
Possible Benefits or Consequences of Being a Personal Guarantor
If your company goes under or delinquent on the loan, it affects your personal credit as guarantor. Lenders will report negative activity on to credit bureaus who will place the information on your report. The negative activity will drop points from your score. On the other hand, they may or may not report positive activity if the business loan is in good standing.
Let’s just say Limited Liability Company (LLC) means nothing in personal guarantee world. Normally when you incorporate or form an LLC entity, it protects your personal assets in most legal and financial instances. Becoming a personal guarantor forfeits those rights for that transaction. If your company defaults, it puts your personal home, car, and funds at risk.
Inc Magazine suggests putting all business officers/executives on the hook. The shared guarantee divides the responsibility and demonstrates commitment from all vested in the company. The general rule for financial institutions is 20 percent or more ownership requires you to sign a personal guarantee. As a safety net, set the same guidelines for owners and officers in your company.
Whether it’s you or someone else who’s the designated guarantor, it can help your business. As a small business, most lenders will require a personal guarantee without collateral. Especially for new business owners. The personal guarantee is only one part of the loan process. Just remember, it’s a means to an end to get money for your company.
When you maintain good payment history, you can have positive reports in your business file. Lenders will see the activity and how you’ve handled the first loan.Once you’re ready for other types of financing, the trust you’ve established will make a difference. Your next loan or line of credit could be a larger amount, have better terms, or come from a more reputable lender.
Don’t feel a personal guarantor is your only option for getting unsecured business funding. But after understanding how does being a guarantor affect your credit score, you may feel comfortable signing. Before you put ink to paper, think about a few precautions.
If you sell the business or your shares, update personal guarantor arrangements.
Even if you’re no longer the company owner or officer, you signed the personal guarantee. That means you’re still responsible for the loan if the business defaults. It should be the new shareholder’s responsibility to pay. Negotiate with the lender and new owner to dissolve or transfer the personal guarantee.
Think twice about being a personal guarantor if it’s not your business.
Being an owner or executive officer is one thing. It’s a different animal if you’re a regular employee or not affiliated with the company at all. Think about your interest in the business and why they would want you to take such a risk. Request to review and have updates on the financial status of the company.
Review documents carefully and consult a business lawyer.
The different types of guarantees and financial obligations can complicate things. Some lenders may make you responsible for fees, legal costs, and back interest. Read and re-read your contract and all the fine print. It’s best to work with an attorney familiar with the document and terminology.
Funding options for small businesses are broadening, but not without accountability from owners and officers. New and seasoned entrepreneurs looking for business cash may have to sign a personal guarantee. Being a personal guarantor is risky, like all other areas of business, but you can benefit from it. Review your contract, weigh the risks, and be financially responsible.
When applying for a business credit card, does being a guarantor affect your credit score? It possibly could. Creditors request your personal information when you apply for a card. They may also report credit activity. Before applying for a company credit card, visit BusinessFinancingHub.com to learn more. Compare your options and apply online today!