A personal guarantee protects a lender in cases where businesses are unable to pay back their debts. It is therefore imperative that you understand what a personal guarantee is before committing to it by signing.
Business loans and personal guarantees
Every business-minded person hopes that he/she can get a loan that can propel their businesses to the next level. It is the hope of each one of them that they will repay their debts on time to avoid penalties. However, some misfortunes do occur, and some businesses end up failing to settle their loans on time. Because of this, lenders have devised mechanisms that ensure that they get their money back regardless of what happens. This is where personal guarantees come into play. This is basically a promise that the loan will be repaid even if the business does not have enough money to make payments. These guarantees are usually signed during the loan application process and come in different types.
Types of personal guarantees
There are two main types of personal guarantees:
- Unlimited personal guarantees
- Limited personal guarantees
Unlimited personal guarantees
With this kind of personal guarantee, you agree through signing to allow the lender to recover 100% (all the amount you owe the lender) of the loan amount inclusive of any legal fees that are associated with the loan you borrowed for your business. In case you fail to honor the agreement, the lender has a right to go after your savings, your kids' college funds, and your personal assets such as a car among others to repay the loan, interest and legal fees. For example, if you borrowed $100,000 and default on it, and your lender incurs $10,000 legal fees to get a judgment on the loans you will owe the lender $110,000 that can be recovered from anything valuable under your possession. They are called unlimited since they offer a borrower zero financial protection if you or your business fails to pay.
Limited personal guarantees
As suggested by the name, limited personal guarantees set a limit on what can be recovered and what cannot in case your business defaults on the loan. These types of personal guarantees are used in instances where multiple business partners jointly take a loan for a single company or business. According to the SBA standards, a person who has 20% and more of the stake in the business should be among the guarantors. It sets a piece of debt that each individual is required to pay in case the business fails to repay the debt. As easy and sweet as limited personal guarantees may seem, it has its downsides. As such, you should check the terms carefully before signing. For example, you should be sure of whether you are either signing several or joint and several guarantee. A several guarantee gives each party a specific percentage of liability while a joint and several guarantee makes each party liable for the full debt amount.
Having known what personal guarantee is and the types of personal guarantees that exist, you should comfortably be in a position to choose the right one next time your business is in need of a loan.