Signing a personal guarantee as part of a business loan agreement makes you personally liable for the debt if the business defaults on the loan. There are some benefits to using a personal guarantee, including potentially better interest rates. But it also means you’re putting your personal assets at risk if your business experiences a downturn and can’t make its loan repayments on time.
Learn what a personal guarantee entails, what risks it involves, and what to know before you sign one for your next business loan.
Key Points
• A personal guarantee makes the borrower personally liable for the repayment of the business loan. If the borrower fails to repay it, the lender can seize their assets.
• There are unlimited guarantees, which cover the full amount of the loan, and limited guarantees, which restrict liability to a specified amount or percentage, providing some measure of protection for the lender.
• Defaulting on a loan with a personal guarantee can negatively impact your personal credit score, as the obligation may be reported to credit bureaus.
Personal Guarantees Explained
A personal guarantee is a legal obligation that an individual will be financially responsible for a business debt if the business itself can’t repay the financing. If a business owner signs a personal guarantee as part of a loan agreement, he or she must cover the debt with personal assets in the event of the business defaulting. If you apply for a loan with this type of agreement, your personal credit history will be reviewed as part of the loan application process (and in addition to your business’s financials).
As part of a personal guarantee, you may need to pledge assets. Typically, assets could include your checking and savings accounts, vehicles, and real estate (like your home). It’s important to know what’s included in the guarantee because it should name the assets at risk if the loan goes into default.
Despite the risks to your personal assets, you may decide that it’s worth signing a personal guarantee. It can help strengthen your application for small business financing, especially if your company has poor credit or no credit history.
Limited vs Unlimited Personal Guarantees
There are two primary types of personal guarantees: limited and unlimited personal guarantees. It’s important to understand the differences because your responsibility varies significantly depending on which type the lender requires.
Limited guarantee. This option is usually designed when there are multiple business owners making the guarantee. Each owner is responsible for up to a certain percentage or amount of the outstanding balance if the loan goes into default. Five partners, for instance, might each have a limited guarantee of 20% of the loan balance.
Unlimited guarantee. This type of guarantee requires one principal personal guarantor who is responsible for the full amount of the small business loan. In addition to liquid assets, the creditor may also seize physical assets like cars or real estate in order to recoup a defaulted loan.
Why Do Lenders Ask for Personal Guarantees?
A lender may require a personal guarantee as an extra layer of financial protection in case the business is not able or willing to repay the loan. Personal guarantees both mitigate lender risk and demonstrate borrower commitment.
Mitigate Lender Risk
Without a personal guarantee, there aren’t many ways for the lender to be reimbursed for the outstanding balance, particularly if the business doesn’t have significant assets to liquidate. Having the option of this legal recourse through an individual reduces the lender’s risk of losing money on the loan.
Some forms of financing (like heavy equipment financing or merchant cash advances) are inherently tied to some type of asset or receivable. That may give the lender more confidence that the borrowed funds will be repaid or could easily be recouped in some way.
Demonstrate Borrower Commitment
Personal guarantees also demonstrate borrower commitment. If the borrower fails to repay the loan, they are at risk of losing their assets. The lender knows the borrower is serious if they’re willing to put their assets on the line, and may be more likely to lend to them with favorable rates and terms.
Types of Business Financing That Require a Personal Guarantee
A personal guarantee is generally required for small businesses and startups. These businesses may not be fully established yet, so using an owner’s or partner’s credit can strengthen the application. And using debt financing secured with a personal guarantee can allow you to retain ownership of your company rather than hand over a chunk of equity to external investors in exchange for funding.
The following types of business financing typically need a personal guarantee:
SBA loans
SBA loans may require an unlimited personal guarantee for any individual owning 20% or more of the business applying for a loan. That also means your personal credit score is reviewed as part of the loan application. There are multiple types of SBA loans, so you can explore all options and determine which financing solution is best suited for your needs.
Short-Term Business Loans
There are many different types of short-term business loans, some of which may require a personal guarantee. These loans are typically used to help with cash flow issues or emergency expenses. You can often apply online and get quick funding if you qualify. Term loans are likely to be secured by a guarantee, so check your offer carefully.
Long-Term Business Loans
These loans typically last anywhere between three and 10 years, or even longer if your business is making a major capital investment like real estate. Depending on the situation, you may be able to use business assets (like equipment or property) as collateral for long-term business loans. But personal credit may also be considered as part of the loan application and a personal guarantee or blanket lien on the business could be a stipulation to qualify.
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Benefits of Personal Guarantees
While a personal guarantee increases your financial responsibility for the success of your company, there are some benefits that come along with it. Most importantly, it can help your business qualify for financing for which it might otherwise not be eligible.
Increases Approval Chances
A personal guarantee helps increase your chances of approval for the loan. The lender views you as a less risky borrower because if you default on the loan, the lender can seize your assets. This allows them to recoup some of their losses if the business cannot repay the loan.
May Get Better Loan Terms
A personal guarantee could also improve the conditions of your loan. While there’s an increased risk for you, you might receive a lower interest rate, a larger loan amount, or a longer payoff term. In fact, some business owners use a personal guarantee even when it’s not required just so they can take advantage of these benefits. The better your personal credit, the better the business loan terms you can expect.
Risks of Personal Guarantees
Signing a personal guarantee brings with it a significant amount of risk for the borrower. If the business defaults on the loan, legal action could be taken against you to repay the loan balance. You could lose your personal assets. But note that some states have homestead laws, which prohibit creditors from seizing your primary residence and retirement savings accounts.
If things go badly for your business, the repercussions from signing a personal guarantee can harm both your business and personal credit scores. Plus, you may be responsible for the lender’s legal fees if it must take legal action in order to collect the debt. That amount is added to whatever balance you have on the business loan, as well as your own legal fees.
It’s difficult to get out of a personal guarantee before the loan is paid off. Filing for small business bankruptcy typically doesn’t get you out of a personal guarantee — only personal bankruptcy can do that. The personal guarantee may also stay in place even if you sell your business. That’s one more reason that it’s vital to understand the conditions of the guarantee in all possible situations. It’s a good idea to have an attorney review your loan agreement so you fully understand your responsibilities before you commit to the financing.
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How Does a Personal Guarantee Affect Your Finances?
Signing a personal guarantee can affect your finances, but usually only if the loan goes into default. If your business is up-to-date on its loan payments, it usually doesn’t show up on your individual credit report. However, future personal loan applications may ask if you have a personal guarantee elsewhere. In this instance, you could limit your ability to qualify for other financing because of your increased debt-to-income ratio.
Impact on Personal Credit
If your business defaults on the loan, that could show up on your credit report, as would any collections or judgment issued. Negative or derogatory marks on your credit report typically last between seven and 10 years. The more severe the default, the lower your score will drop. This can impact your ability to qualify for financing for years to come. And if you do qualify, you’ll likely be subject to extremely high interest rates.
Seizure of Personal Assets
A personal guarantee can also affect your finances if you go into default and the lender seizes your personal assets. If you put up a savings account as collateral, for example, the lender could take this. Before taking out any type of small business loan with a personal guarantee, it’s important you have a plan in place to pay it back.
Finally, a personal guarantee that goes into collections could impact your spouse, too, if you don’t explicitly have joint assets excluded from the guarantee.
Alternatives to a Personal Guarantee
Lenders are likely to want some form of security to lower their risk when they extend loans to businesses with less-than-stellar credit or no track record. There may be options that can take the place of a personal guarantee in terms of allowing you to obtain better credit terms.
Collateral. One way a business may be able to get better terms on a loan is by offering collateral. Collateral is an asset or set of assets that helps secure the loan and lowers the risk for the lender if the company defaults on the loan. In the event of default, a lender can claim your pledged collateral for the debt owed.
Blanket business lien. This is similar to a personal guarantee, except that it offers up not your personal assets but the business’s assets as security. If your business fails to repay and defaults on the loan, the lender is entitled to possess and/or liquidate your business’s assets to fulfill your debt. Note that some lenders may require a personal guarantee in addition to a blanket lien, meaning that if your business assets aren’t enough to pay back what your business owes them, they can go after your personal assets, too. There’s another argument for reading the fine print carefully.
The Takeaway
A personal guarantee is commonplace in the world of small business loans. But it’s still important to understand the full scope of your responsibility so that you’re aware of the risks and certain that you’re willing to take them.
Although agreeing to a personal guarantee is likely to improve the terms of the loans you qualify for, it’s good to know what’s on offer without a personal guarantee as well as with one.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is a personal guarantee?
A personal guarantee is a legal commitment by an individual, usually a business owner or partner, to repay a business loan if the business itself is unable to do so. It makes the guarantor personally liable for the loan, meaning that their personal assets can be pursued by the lender in the event of default.
How does providing a personal guarantee impact my personal credit score and financial standing?
Providing a personal guarantee can impact your personal credit score if the business defaults on the loan and the lender reports the default to credit agencies. It’s important to make sure you pay your loan on time each and every month.
What are the consequences if my business defaults on a loan that I have personally guaranteed?
If the business defaults on a loan with a personal guarantee, the lender can pursue the guarantor’s personal assets, such as bank accounts, real estate, and other property, to recover the owed amount. This can lead to significant financial strain and potentially impact the guarantor’s personal financial stability.
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