When applying for a loan of whatever nature, borrowers may be asked to have their application signed by a guarantor or get a co-borrower. This is especially the case if the borrower has a low credit rating or their income is insufficient to assure the lender of their loan repayment.
If you find yourself in a position where you are being asked to guarantee a family member, a friend or a colleague, knowing the difference between signing as guarantor or as a co-obligant is important. Read along to find out what these differences are.
Who is a Co-Obligant?
Generally, a co-obligant is a person who is bound together with others in the fulfilment of a common obligation. In the context of financing, a co-obligant is a person who together with another one jointly applies for a loan.
Lenders usually view loan processes where co-obligants are involved as less risky. This is because the repayment obligation is shared among the co-obligants. Chances of default in such cases are minimal. Borrowers may qualify for guarantor loans low APR because of the increased security layers.
Jointly and Severally Bound
The co-obligants may be severally or jointly bound. Each of these terms means something different and understanding them is equally important.
When getting into a partnership whether as a form of business or for purposes of getting a credit facility, the parties involved must establish the extent of their liabilities.
When parties are jointly and severally liable, they are equally responsible for ensuring that the terms of the agreement are fulfilled.
For instance, if you take a loan of £25,000 and you become jointly and severally bound, all co-obligants are equally liable for the entire £25,000. Their responsibility ends when the full amount has been repaid to the lender. In case of a default, the bank will pursue either of the parties for full repayment of the arrears.
Assume co-obligant A is sued by the lender, he will have legal recourse against co-obligant B, but this will come after he has repaid the loan in full. Therefore, co-obligants are on the first line of pursuit in case of loan defaults.
Each party to the loan agreement is responsible for their respective portion as stated in the agreement. As opposed to joint liability where they carry the full burden, in this case, each obligator carries a portion of it.
You may also come across terms such as co-signor or co-borrower. All these mean the same as co-obligant.
Who is a Guarantor?
A guarantor is someone who steps in to help a borrower get approved. For instance, a borrower who is either a young person with no credit history or someone with bad credit may seek a guarantor to help them get approved.
As opposed to a co-obligant, a guarantor does not receive the credit, but rather gives the lender an extra layer of security assuring him of repayment of the loan granted. Anyone can be a guarantor if they are over 21 years of age. As a rule of thumb, a guarantor must have a good credit history, be financially stable, and be well known to the borrower.
Why Borrowers May Need a Guarantor
There are many reasons why a borrower may approach a guarantor some of which are:
- Low credit score – Chances of a borrower getting approved with a low credit score are very slim. In this case, the backup of a guarantor is needed to reassure the lender that the loan will be repaid.
- Limited or no credit history – Just like a low credit score, limited credit means that a borrower does not have enough financial history to convince a lender of their ability to repay a loan once granted.
- Low income – The ability to repay a loan is pegged on the cash flow. If a lender has a reason to believe that the borrower has insufficient income, they may need the reassurance of a guarantor just in case the borrower defaults.
Before you consent to be a guarantor, ask yourself why someone wants you to be their guarantor. In case they have a bad credit history, assess whether they will be able to manage the repayments. Also establish if they really need the loan and in case they default, whether you covering their repayments will affect your relationship.
The Implications of Being a Guarantor
Being a guarantor exposes you to financial risk if the borrower fails to honour their repayments. Your home may even be repossessed to help cover the arrears. Depending on the loan covenant, you may be a guarantor for the entire term of the loan.
Once you have signed the agreement to be a guarantor, the lender may hold you accountable until the loan has been paid out. This is because the approval of the loan in the first place was influenced by your attributes including employment status, credit history, and other factors.
Both co-obligants and guarantors may have their credit scores affected if repayments are not made in time. Once a loan falls into default, it will be added to the credit report of both the guarantor and the co-obligator.
Another aspect you have to be careful about is the impact of the loan on your future borrowings as a guarantor. Lenders will assess your cashflows to determine if you can afford a facility. Any debt you guarantee represents a contingent liability that is often factored in assessing your creditworthiness.
Guarantors and co-obligators play complementary roles in loan processing and approval. A co-obligator is usually assessed together with the rest of the borrowers before a loan is approved. Where co-obligators do not have what it takes to get approved, a guarantor must step in to provide an extra layer of collateral.
The lender may carry out a credit check for the co-obligators and a guarantor check for the guarantors before accepting to process the loan.