When it comes to signing a loan contract, whether it be for real estate, a lease, a car, boat or any type of service, most people will sign a contract with the intention of complying with its terms. In the event a borrower defaults on a loan agreement, one of the more potent provisions in a lender’s arsenal of legal remedies is to pursue the borrower on their personal loan guaranty.
A loan guaranty is an agreement by which one person assumes the responsibility of assuring payment of another’s debts or obligations. A guarantor can be an individual or a company. In the event of default, the guarantor will be called upon to make the payments, pay the entire loan balance, or step in to perform the required service. Under a loan guaranty, a guarantor, if not the borrower, is not obligated on a loan until a default is actually declared by the lender.
There are four ways to limit a guarantor’s legal and financial exposure, and all parties to the agreement must agree to the terms of the guaranty before signing. The four ways to limit exposure under a loan guaranty are:
1. Place a limit on the amount of the guaranty. For example, the guarantor agrees to be responsible for the first $100,000 of a $500,000 loan.
2. Reduce the amount of the loan guaranty over time. For instance, the guarantor will not be held responsible for the loan once the borrower has performed on the note for a specified period of time, say 48 months. Or after the first three years, the amount of the guaranty is reduced by $X amount of dollars.
3. Make the guaranty enforceable against the guarantor only after the lender has sought all other legal remedies against the borrower. Only then is the guarantor responsible for the amount that the bank could not collect from the borrower.
4. Multiple loans. Guarantors should use caution if and when a borrower has multiple loans with a particular bank. Make sure that the guaranty specifies the loan obligation that it intends to secures. There should be no confusion that when a loan is paid off the obligation is extinguished. Otherwise it is feasible that the guaranty could continue to secure any of the remaining multiple loans.
On a final note, tearing up a signed loan guaranty while standing in the middle of a bank lobby does not relieve a guarantor from their obligation.
Agreeing to be a loan guarantor is a serious legal and financial responsibility. It is a legal arrangement that should not be entered into lightly. It’s exciting to be approved for a long awaited business loan or equity line of credit. Defaulting on a loan is the last thing business owners and consumers contemplate when borrowing money, yet the provisions written in the loan agreement are there in the event that one does. Seek competent legal representation before you close your loan. Always remember that bank attorneys drafted the loan documents.