Why Do Banks Want Personal Guarantees?

Why Do Banks Want Personal Guarantees?

A personal guarantee is an agreement between an individual and another entity, usually a bank, finance provider or product supplier that makes the individual (the guarantor) liable for the debt of a third party (borrower).

Banks commonly request personal guarantees as secondary security.  This is to ensure that should any primary security, for example a registered mortgage over real estate, be insufficient to cover the full amount of the loan or finance in the event of a default, the bank will have further recourse and another avenue to pursue recovery of monies.  When you give a personal guarantee to a loan you are promising to pay to the bank any amounts owed on the loan in default.  It is important to note that the bank does not need to exhaust all avenues of recovery of money from the initial borrower before making a request to a guarantor to pay any outstanding amount.  Many people are under the incorrect assumption that the bank must have recovered as much from the borrower or any security held as they can before requiring payment from a guarantor.  However, in fact should there be a default regardless of how minor, this enlivens the guarantor provisions.

If you own a business or a company, it is likely that when borrowing money the bank may have asked you to provide a personal guarantee for the amount being borrowed.  It is important that you properly understand what is involved when giving a personal guarantee and the risks so that you are able to make an informed choice as to whether you would be willing to enter into the same to further your business interest.

When you sign a personal guarantee you are promising that you will make payment if a default occurs.  Before entering into or guaranteeing any business or third party loan, it is important that you consider the benefit to you.  In many cases there is no direct benefit to an individual to signing a loan guarantee on behalf of another.  It is often that a guarantor will take a lot of the risk for little or no reward.  It is important to consider the following before agreeing to provide a guarantee:

1.How does the borrower intend to repay the loan?

2.What is the amount of the guarantee? Is it limited?

3.Will you be able to afford to repay the loan if the borrower cannot/does not?

You are able to request a withdrawal or reduction of a loan guarantee that you have already provided.  However, whether this withdrawal or reduction is granted is likely to be determined on many factors including the repayment history of the borrower, the amount outstanding on the loan and whether or not the bank feels comfortable that they have more than enough security without your guarantee to ensure repayment of the loan.

Many people run their business through a corporate structure which means that, provided they have acted properly, they can be shielded by the separate legal entity from any risk to their personal assets.  This is a further reason why banks request personal guarantees.  It means that if the business experiences financial difficulties the bank still has the ability to recover their funds from the guarantors.  Often a bank will require a party to obtain independent legal advice before signing the guarantee.  This is to ensure that you have had proper advice and time to consider the effect and risks associated with the guarantee.