Bankruptcy Basics: The Personal Guarantee
When taking out a loan, a personal guarantee is your promise that you’ll repay the loan, sometimes based on good credit, sometimes with collateral to back the loan. For some people, perhaps those just starting out establishing a financial history, getting a personal or business loan is difficult without a cosigner or guarantor.
A co-signer is used to help boost the debt-to-income ratio for the borrower, so the borrower is better able to qualify for the loan. The co-signer holds the same liability as the primary borrower, and if the primary borrower is unable to pay the loan, the co-signer will become liable. For business loans, a guarantor is the equivalent of a cosigner, although the stakes are usually much higher. If the original borrower defaults on the loan, the guarantor can see his or her credit rating take a hit.
If a person or business owner is able to get a loan based on a personal guarantee – a contractual promise to pay back the loan – they may do so with the assistance of a cosigner or guarantor. While that arrangement may work well for all involved, there may come a time when personal or business finances become difficult, and bankruptcy may become a consideration.
Loans obtained by personal guarantees – unless they are student loans or loans that are part of divorce proceedings – are usually able to be dissolved as part of bankruptcy proceedings. There are several different types of personal guarantee loans, however, and bankruptcy impacts each one differently.
- If the loan is an individual loan and the original borrower fails to make payments, the lender can send that debt to collections. Bankruptcy is an option for erasing the debt, but if the borrower put something of value up as collateral, that could be used to cover the lender’s losses.
- If someone signs on as a guarantor and the borrower they co-signed for fails to pay, the guarantor becomes wholly responsible for the loan. If they, too, are unable to pay, they can also file bankruptcy to absolve themselves of the debt.
- Bankruptcy is not an option for sole proprietor business debts because there is no legal business in place due to contract wording and other legalities, making any business debts personal debts.
- Small business debts are personally guaranteed, and guarantors will be asked to pay if debtors default on loans. Both parties have the option of filing bankruptcy, however, to cover expenses.
For more information about personal guarantees and how bankruptcy may or may not impact them, contact an experienced attorney to help you decide whether you want to take on a role with such a big responsibility. For more information or for a consultation, please contact Maxwell Dunn’s team at 248-246-1166.See all videos