Personal Guarantees and Business Loans

What is a personal guarantee?

A personal guarantee is a document that a borrower signs pledging to repay the balance of a loan in the event of default or if the property securing their loan declines in value. Personal guarantees can be used for business or personal loans; but in both cases, these guarantees create broader liability for borrowers and co-signers to repay loans.

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In some cases, a personal guarantee can be the only security that borrowers provide for some types of loans – such as credit cards and personal loans. More often, personal guarantees are provided as additional security for business loans – including SBA loans – in addition to property collateralizing a loan.

Loans that include personal guarantees are different from loans that don’t – called nonrecourse loans. Nonrecourse loans don’t require any type of personal guarantee, limited or unlimited, from a borrower or co-signer. If your business defaults on a nonrecourse loan, the lender can’t go after you or your assets. All the lender can do is foreclose on the collateral securing the loan, and sell it to recoup as much of their money as possible.

Personal guarantees provide another avenue for a lender to recoup their money if your business defaults on its loan. While this reduces the risk of a loan for lenders, it increases the risk for borrowers.

How do personal guarantees work for business loans?

When you choose a small business loan for your company, typically every person who owns at least 20% of your business must be included on the loan application and provide a personal guarantee for at least a portion of the loan. These guarantees are in addition to any collateral being used to secure the loan. 

When these personal guarantors apply for the loan, their personal credit is checked and considered when your company is being vetted for the loan. If you sign a personal guarantee, you are personally liable for the loan balance – or a portion thereof. 

If your business later defaults on the loan, anyone who signed the personal guarantee can be held responsible for the remaining balance, even after the lender forecloses on the loan collateral. The lender can sue individual business owners who personally guaranteed the loan – if necessary – and obtain judgments for certain amounts. This can lead to guarantors having to sell other property or having their wages garnished to pay off their part of the balance.

While personal guarantees can require individual business owners to pay part of a business loan, these guarantees do not require guarantors to put cash in escrow or pay any money in advance of securing a loan. Signing a guarantee only means that you can be held liable – either for a specific amount or up to the unpaid loan balance – if the business defaults, but no collective action occurs until a default happens.  

What is required for a personal guarantee?

Signing a personal guarantee can drastically increase your liability when obtaining a loan, but the process of providing one is actually very simple. If a personal guarantee is required for a loan, it’s typically built into the loan process. Here are the steps for providing a personal guarantee:

1. Apply. Complete a full loan application, and provide all personally identifiable information.
2. Gather documents. Supply your personal financial information for review, including any interests outside the business requesting the loan.
3. Review records. You might need to review the financial records of any outside business interests.
4. Check your credit. Complete a hard or soft credit check.
5. Set it up. Negotiate a limited or unlimited personal guarantee.
6. Sign. Sign all loan documents, including lien and guarantee agreements.

Regardless of what type of business loan you’re applying for, the lender will walk any necessary guarantors through the underwriting and signature process. Borrowers won’t need to do anything special besides provide information when it’s requested and sign the required documents.

Types of personal guarantees

There are two types of personal guarantees: limited and unlimited. Limited personal guarantees require signers to guarantee a portion of a business loan up to a specified amount, while unlimited guarantees do not have any stated cap. With an unlimited personal guarantee, guarantors are liable for any part of the loan balance that is unpaid after the lender auctions off other collateral securing the loan.

In many cases, lenders will add these items to the outstanding loan balance, and personal guarantors can also be held liable for them:

• Accrued interest
• Late fees and penalties
• Attorneys’ fees
• Court costs

Personal guarantees and credit scores

Before you sign a personal guarantee on a business loan, you’ll first complete a loan application process that includes a personal credit check – either hard or soft. These credit checks are usually required for all business owners who own at least 20% of your company.

A credit check can actually hurt the prospective guarantor’s credit since it counts as a ding on their credit score. And, if your business ultimately closes on the loan and the guarantor signs a guarantee, the loan will show up on their credit report.

If a person providing the personal guarantee doesn’t have good credit, it may also impact your ability to acquire the loan – the same as if your company didn’t have enough collateral or didn’t show strong cash flow strategies – to cover the prospective payment.

Risks of personal guarantees

Personal guarantees drastically increase risks to borrowers beyond being held liable for the loan if the business defaults. Guarantors may suffer damaged credit or may be unable to secure a personal loan – including a mortgage. 

Here are some specific risks associated with signing a personal guarantee for a business loan:

• A guarantor’s personal credit score may be impacted.
• A guarantee could impact the guarantor’s ability to get a personal loan later.
• A guarantor’s credit may suffer even more if your business defaults on its loan.
• Guarantors may get sued and have to pay attorney fees and court costs.
• You may have to sell personal assets to fulfill the guarantee.
• Wages may be garnished if guarantors can’t fulfill their guarantee.
• Guarantors may have to file bankruptcy if they can’t cover the debt.

Despite the risks, providing a personal guarantee is often the only way to secure a small business loan and amass the financing your company needs. If you are adamant about avoiding personal guarantees, you may need to consider alternative financing options – such as crowdfunding and microloans.

Aside from credit cards, personal loans used for business – and some loans tied to specific assets, such as equipment or real estate – most business loans require personal guarantees from 20% or more of company owners.

Should you sign a personal guarantee for a business loan?

If you own 20% or more of a small business and are trying to get a small business loan, you’ll probably be required to sign a personal guarantee. That’s why small business owners must understand how personal guarantees work, and have business partners and managers they can trust. 

After all, if you sign a personal guarantee on a loan and the proceeds are misused or misappropriated, you can still be held liable for the total value of the loan – plus fees, interest and penalties.

If a business grows to a certain size, a personal guarantee may not be required. However, signing a personal guarantee may still qualify a business for considerably better terms or a lower interest rate, making it a good decision. But if signing a guarantee doesn’t improve the terms of your loan offer, then signing a guarantee and increasing your liability may not be a wise choice.