6 Issues to Consider Before Agreeing to Be a Loan Guarantor
If you have been approached by a friend, family member or business associate to act as a guarantor for their loan, it is crucial that you understand the consequences should you agree to sign as guarantor. Many guarantors sign their friend’s loan agreements for a vehicle purchase without a second thought, forget all about it and are shocked to later receive a legal demand for repayment from the lender, when this is precisely what they signed up for.
Once you sign up to be a guarantor, it can be difficult to change your mind later. Carefully consider the following 6 issues before agreeing to become a guarantor.
1. Are you able and willing to pay the loan amount?
This is the single most important question you need to ask yourself. By signing as a guarantor, you are essentially agreeing to step into the borrower’s shoes and, in certain circumstances set out in the loan agreement, take on all of the borrower’s obligations – most crucially, the repayment of the loan amount at the interest rate set out in the loan agreement.
Ultimately, you need to be prepared to accept the risk that the lender will seeks to recover the loan from you.
There are many scenarios in which the lender can demand repayment from the guarantor and it is very difficult to accurately predict the likelihood of any one of those scenarios happening. Therefore, if you sign on as a guarantor for a friend, make sure it’s a friend whose loan you won’t mind paying in full if necessary without damaging your friendship.
If the amount of the loan together with the interest is more than you are prepared to lose, do not sign.
2. How likely is it that the borrower will be able to repay the loan?
This is very difficult to reliably evaluate. Consider:
- The borrower’s other liabilities and existing loan repayment commitments (e.g. property mortgages, credit card or motor loans)
- The amount and reliability of the borrower’s income
- The borrower’s credit history
These are all issues the lender will have considered in giving the loan. You, as a guarantor, will be bearing even more risk than a lender and so should do at least as much due diligence as a lender.
Demand copies of salary slips, other loan repayment schedules and credit history reports from the borrower. If the borrower cannot or will not provide them, consider objectively whether this borrower, even though he/she may be a good friend, represents a huge risk that you will ultimately have to pay for.
3. What other circumstances would trigger an obligation to pay?
Some loan agreements allow lenders to recall the loan from the guarantor in scenarios other than the borrower’s failure to keep up with payments. These scenarios, including various minor breaches of certain terms of the agreement or changes to the borrower’s personal circumstances.
In addition, be warned that loan agreements often do not contain provisions that require a lender to try to recover payment from the borrower first before seeking payment from the guarantor. Frequently, the borrower and guarantor are also both explicitly designated as being jointly and severally liable for the debt. If so, this means that the lender can choose to pursue either or both parties for repayment, at its option. In such a scenario, prepare yourself for the possibility that the lender may choose to pursue you for repayment even though the borrower has not defaulted on payments.
4. What are the consequences if you are unable to pay when the lender seeks to recover from you?
If you don’t have enough savings to meet any demand for payment, you will need to be prepared for some unpleasant consequences.
One possibility is that the lender obtains an order for seizure of any personal property you own which can be sold off to pay the debt. Another is that the lender obtains a garnishee order allowing them to deduct the debt automatically from your monthly salary.
The most likely outcome is that the lender simply applies to make you bankrupt. The consequences of bankruptcy are extremely serious and include restrictions on your ability to leave Singapore without explicit permission from the Official Assignee, your ability to engage a lawyer to sue someone (including the borrower), your ability to hold a directorship of a company or eligibility for many kinds of employment.
Being made bankrupt may also automatically render you in breach of many other kinds of contracts that you may have with other entities (e.g. employment contracts and banking/credit facilities agreements) and can result in a cascade of other claims against you from those entities, or refusal of those entities to continue to deal with you.
5. Can you sue the borrower to recover the debt from them?
Yes, in theory you can. But in all likelihood, if the lender decided that it would be easier to recover from you than from the borrower, then the borrower they probably doesn’t have the money to pay you.
6. Is the borrower a limited company of which you are the main shareholder/director?
When lending to private limited companies, lenders often prefer to have a natural person linked to the company as a guarantor. This is in order to circumvent the limited liability that comes with dealing with a company so that a company can’t avoid paying its debts by going into insolvency while the directors/shareholders are unaffected.
If you agree to be the guarantor for your company’s loan, be aware that this is why you’re being asked to do this and consider the risk factors discussed above by reference to the company’s profitability and cashflow.
One way to try to avoid being on the hook in your personal capacity for a company loan is to set up a holding company wholly owned by you and to which ownership of your company can be transferred. This is provided that your company’s credit needs have been forecasted well in advance. You can then offer this holding company to the lender as the guarantor instead.
This is by no means foolproof and many lenders, after proper due diligence, may well decline to accept such a shell company as a guarantor. However, if the lender accepts the arrangement, this can allow you to exclude any personal liability for the loan.
Agreeing to act as guarantor for a loan is a major responsibility and entails very real risk of having to repay the entire loan with interest. Loan agreements are always drafted to make it easy for the lender to force you to pay up – they are a minefield of clauses designed to make it very difficult for either you or the borrower to resist paying.
For this reason, it is always advisable to have a lawyer review the agreement for any loans which you have been asked to be a guarantor for. While the lawyer will unlikely be able to help you negotiate a better agreement, he/she will at least be able to advise you as to the real implications of what you are signing so you can make a fully-informed decision regarding the magnitude of the risk you will be taking on.
If any lender shows reluctance to allow you to take a copy of the draft loan agreement to obtain legal advice, this should set off alarm bells about the propriety of the whole arrangement. Even after ensuring that the lender is legitimately registered as a licensed moneylender, you should think twice about going through with the loan and advise the borrower to do the same. If in doubt, speak to a lawyer.
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