Friends and relatives who offer to guarantee loans for someone who can’t get a loan due to their poor credit history need to tread carefully, as they could be unwittingly signing up to mountains of debt.
What is a guarantor loan?
With a guarantor deal, a creditworthy friend or family member agrees to provide security for someone else’s repayments.
The guarantor effectively assures the lender it will get its money back, as they will pay back the money if the borrower fails to do so.
Who takes out this type of loan?
Guarantor loans are usually taken out by those with impaired credit records who find it difficult to get loan from a mainstream bank or building society.
Lenders must assess whether potential borrowers can really afford to repay their loans before agreeing to advance them funds.
Who can be a guarantor?
To be a guarantor, you must be a friend or family member. But the person cannot be connected to you financially – meaning you cannot be a guarantor for your spouse or partner.
What’s the issue?
While a guarantor loan can provide a real helping hand for someone struggling to borrow, it’s important to be aware that the loan repayments the friend or family member is effectively ‘underwriting’ often come with high rates of interest.
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How expensive are they?
Guarantor loans are expensive products and can come with rates approaching 50%.
This reflects the borrower’s poor credit profile – and the risk the lender is taking on.
Friends and family don’t realise what they are getting into
There are concerns that many people who have agreed to these arrangements are unaware of their full obligations.
If you sign up as guarantor, you are agreeing to pay the loans if the friend or relative gets into difficulty and defaults.
While you will only be called upon as a last resort, if you are called upon, you will have to take over the repayments until the loan is paid off. This could mean you end up getting chased for large sums of money – and will have no choice but to pay.
What action is being taken?
In recent years, other areas of high-cost borrowing, such as payday lending and doorstep lending have been subject to a regulatory crackdown. But as yet, guarantor loans have been left alone.
That said, in March 2019, City watchdog, the Financial Conduct Authority (FCA), said guarantor loans were ‘in its sights.’ This came after concerns were raised that guarantors were increasingly being called on to pay off the debts.
Guarantor loans becoming more popular
Guarantor loans are a fast-growing corner of the sub-prime lending market.
This is especially the case now that interest rates on payday loans have been capped – following the FCA crackdown.
What do the providers say?
Firms which provide guarantor loans defend the products, and point out that the loans enable people to rebuild their credit scores as they borrow.
This is because every time the borrower makes a payment on time, they are given a ‘good’ mark on their credit rating.
Know exactly what you are getting into
If you are considering being a guarantor for a family member or friend, you need to go in with your eyes wide open, as these loans carry huge risks.
You need to think carefully about whether you trust that person to make their payments on time each month, and whether they can realistically afford the loan they are taking on.
You also need to ask yourself seriously whether you are happy – and able to – make the payments should you be required to do so.
What are the alternatives?
If a family member or friend is struggling to borrow, there are other options you might want to suggest:
Loan from a family member
If you have funds available, you could lend that person money directly. But make sure you agree terms at the outset and set these down in writing. Also be warned that lending to family members can lead to big disputes if things go wrong.
If the person is looking to borrow a smaller amount of money for the short term, you could suggest they apply for an overdraft on their current account. Costs can be high, so this should only ever be seen as a short-term measure. From April 2020, banks will have to simplify overdraft interest rates and replace per-day fees with a simple interest rate.
You could suggest the friend or relative considers a credit union. These financial institutions offer a handful of financial products, including loans. Rates can vary, and are capped at 42.6% annually. This is a lot cheaper than many short-term loans. But before being able to borrow, certain eligibility criteria need to be met so they can become a member. To find your nearest credit union visit Find yourcreditunion.co.uk.
Tips to help a friend or family member improve their credit score
A really good way in which you can help out a friend or relative who is having difficulties borrowing is by urging them to take steps to improve their credit score.
- First off, suggest they get a copy of their credit report. They can do this for free from a credit reference agency, such as Equifax, Experian or TransUnion.
- Tell them to get registered on the electoral roll.
- Ensure they are making all payments on time.
- Urge them not to apply for too much new credit.
- Tell them not to use too much of their available credit.
- Help them get any mistakes on their file corrected.
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