Keith Gumbinger
Keith Gumbinger, vice president of New Jersey–based HSH Associates, which publishes consumer loan information. HSH.com
Steep real estate and car prices have made it especially difficult for many young adults to qualify for mortgages, car loans and even apartment rentals these days.
One potential solution: Convince someone in a stronger financial position to serve as guarantor of the loan or lease agreement. Lenders and lessors typically will take this guarantor’s finances into account when evaluating the borrower’s or renter’s creditworthiness, improving the odds that he/she will quality and/or the terms offered.
But proceed with caution if you’re asked to serve as a guarantor—these arrangements often bring substantial financial risks.
Serving as a guarantor is very similar to serving as a cosigner—you agree to serve as a financial fail-safe for a borrower or lessee, stepping in to make required payments if he doesn’t.
Main difference: A cosigner is legally responsibility for any required payments that the borrower or lessee fails to make…whereas a guarantor becomes responsible for missed payments only in the event that the primary borrower or lessee defaults, which, depending on contract terms, might not occur until that borrower has missed multiple payments,.
One additional difference: Cosigning arrangements usually appear on the cosigner’s credit report and affect the cosigner’s credit score…while serving as a guarantor typically doesn’t appear on the guarantor’s credit report or affect his/her credit score unless the loan goes into default.
Guarantors, like cosigners, are almost always close relatives of the borrower, but that’s not a requirement—in theory, a friend or another adult could serve this role. Whoever it is, this person should have a credit score, debt-to-income ratio and overall financial profile that the lender will consider attractive—a guarantor helps a borrower qualify for a loan only if the guarantor himself would qualify for that loan.
The risks facing guarantors vary greatly depending on the trustworthiness and financial stability of the borrower as well as the size and length of the loan or lease. Examples: Risks generally are relatively modest with apartment leases because those typically last only 12 months. But car loans typically last five to seven years, with potential financial obligations in the tens of thousands of dollars…and mortgages often last 30 years with obligations in the hundreds of thousands of dollars. If you agree to serve as guarantor of a mortgage, you’re accepting the possibility that you could be responsible for making all of its payments.
What’s more, guarantors, like cosigners, generally have no control over or ownership of the property—even if they end up making the payments. Legal ownership is determined by the name on the title, not who’s paying the bills. In theory, the borrower could stop making mortgage payments and refuse to move out or sell the house.
Helpful: If you agree to serve as guarantor or cosigner for a lengthy and expensive loan, insist that the borrower also sign a separate written contract with you detailing the consequences if you end up having to step in and make payments. This contract could state that if you must make payments, you have the right to demand that the property be sold…and that the borrower must pay you back with interest and cover any legal fees that you incur. If the loan involved is a mortgage, this contract also could state that the borrower must refinance to a new mortgage that does not include you as a guarantor within some predetermined time.
