Guarantor loans are becoming more common and there is a growing number of providers, but a lot of people don't know exactly what guarantor loans are or how they work.
Guarantor loans are a special type of loan for people with poor or limited credit history where their loans is guaranteed by somebody with a good credit rating. If the borrower is unable to repay the loan, the guarantor will have to make the payments instead.
To find out exactly how this type of loan works, read our nifty guide below.
How do guarantor loans work?
Guarantor loans largely work like any regular loan with one major caveat - the guarantor.
As with all other loans, you submit a loan application where you tell the lender information they require to assess your credit worthiness, match you to the credit reference agency and open up a loan account.
Loans work in the same way as normal loans - the money is deposited into your account after all the checks are complete and you make fixed monthly payments for an agreed number of months until the loan is fully repaid.
The way the interest is calculated, the way payments work and most other components of how the loan works looks and feels exactly like any other loan.
In fact, if there are no issues along the way, the guarantor will have no involvement after the application stage and everything about the loan after that will be the same as other regular loans.
Guarantors are involved during the application stage - the applicant names the guarantor and gives basic contact details on the application form. The guarantor then completes their part of the application separately.
The guarantor has a full credit check done on them as they are ultimately liable for the full loan balance. After completing the paperwork, the guarantor then has no involvement in the loan until the loans is fully repaid or in the case of a hiccup.
If the loan is repaid, the guarantor is notified that they are off the hook and that's the end of their part.
In cases where the borrower fails to make payments, the guarantor is required to make the payments instead and effectively takes on the loan from that point onwards.
Who are the guarantors in guarantor loans?
Technically, almost anyone can be a guarantor for anybody else. As long as you are over 18 and have a decent credit score, you can be the guarantor for somebody else's loan.
The issue here is that the guarantor will have to provide all of their personal details to the loan company and will ultimately be liable to repay the full amount of the loan plus fees and interest should the borrower fail to make repayments.
Because of the level of trust required and the potential debt burden being taken on, the guarantor is often a relative or a very close family friend.
The one exclusion here is that in most circumstances you cannot be a guarantor for your spouse. As spouses are financially connected through joint accounts, mortgages and other products, the guarantor's finances are too closely related to the borrower's.
It's important for the guarantor and the borrower to discuss the arrangement before diving into taking out a guarantor loan. While these loans can be a great way for people with limited or poor credit history to borrow money, you want to make sure you talk through what happens in the event things don't go to plan.
Who are guarantor loans for?
Guarantor loans are a way for people with poor or limited credit history to get loans that don't have ridiculous APRs in the 1000s of percent and help them improve their credit score.
There are two main categories of people who guarantor loans are designed to help. Those with poor credit history will have had issues with credit in the past. They may have missed payments on credit cards or loans, had a county court judgement against them or have recently had high debt levels.
Customers with a poor credit history will be rejected by mainstream lenders because their past behaviour suggests they have a high risk of not paying the loan back. However, if somebody with a much lower level of risk guarantees their loan, that opens up the door.
The second category of people for whom guarantor loans are also great are those who have very little to no credit history. These can be young people who have not had any credit before, people who have recently moved to the UK or those who have simply not had the need to borrow in the past.
In a lot of cases, these customers without a credit history will have low risk levels, but without any data to back it up, lenders are unlikely to give them a loan which is where guarantor loans can step in to help.
Guarantor loan interest rates
Guarantor loans are more expensive than traditional loans. While most loans you can get with big banks usually have interest rates of between 3% and 16%, guarantor loans are typically priced at 49.5% to 49.9% APR.
Some of the biggest companies in this space, such as Amigo Loans, Trust Two, George Banco and Buddy Loans all have guarantor loans in this price range.
While it seems expensive on the surface, these loans are still great value compared to a lot of other options that customers who can't get cheaper mainstream loans have.
Non-guarantor loan companies that will accept these customers, will have APRs starting from 400% and go over 1,000%. A lot of these loans will only lend for up to 12 months or even less, not giving you the option of repaying over a 2-5 year period.
When you do the maths, the numbers don't look so bad either. A premium loan at 16.9% will cost £1.31 per £100 borrowed per month. A guarantor loan at 49.9% will cost £3.43 per £100 per month. A subprime loan costing 1,500% (and this is a real alternative) will cost £26 per £100 borrowed.
So while they are more expensive than premium offerings, the rate is still infinitely better than what the subprime loan companies will offer.
Differences between guarantor loans and regular loans
There are a few key differences between guarantor loans and regular loans. The majority of how the loan will work is actually remarkably similar. You still have to apply in a similar way, the lender will still deposit the money into your bank account upon acceptance and you still have to make the same payments as for a regular loan.
Here's a list of what's different:
- You can't get an immediate loan decision. After you submit your application, the lender has to get in contact with the guarantor, ask them to fill in their parts of the application, make a decision based on the circumstances of the borrower and the guarantor and only then confirm the loan offer. Sure - if you're sitting right next to each other, the process can be quick, but it's not instant.
- The guarantor will have to submit personal financial details to the lender. These will include the same information they would submit if they were borrowing themselves. A credit check will be run on their file so take that into account.
- Any post-application checks will involve both, the borrower and the guarantor. In cases where additional documentation is required to confirm identity, address or something else, both may have to provide the required documentation.
- If the borrower defaults on their payments, the guarantor will be fully liable for the loan. If the guarantor does not make the required repayments, their credit history will be affected as will the original lender's.
- The guarantor will know details about your application - how much you are borrowing and what you are stating as the reason for your borrowing. Make sure you are comfortable with that before you proceed.
Important things to know about guarantor loans
Here are a few things you should know before you apply for a guarantor loan. We've covered the relationship between the borrower and the guarantor and the risk that the guarantor takes on, but there are a few other points you should consider.
If you're not sure whether or not you might get accepted for a loan with a lower rate, it doesn't hurt to try that avenue first. Comparison websites and many lenders only run a soft credit check when you apply for a loan that will not leave a mark on your file.
Even if you proceed with a full application, your ability to get a guarantor loan will not be affected by checking first as it is the guarantor's profile that is critical in the decision making process.
It might seem like a good idea for the guarantor to apply for a loan in their name and simply lend the money to you. They can get a better rate and you may have to pay less interest as a result.
The problem with these arrangements is that they are not structured or regulated and can become an even bigger issue with making the monthly repayments and relationship breakdown.
Secondly, the guarantor will have a loan against their name on the credit bureau which will affect their own credit score and ability to borrow in the future. If they want to take out a loan themselves or get a mortgage, this can be a disadvantage.
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