What Is a Personal Guarantee?

Lauren WardUpdated March 2, 2023

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It's incredibly important to learn what a personal guarantee is.Signing a personal guarantee as part of a business loan agreement makes you personally liable for the debt if the business defaults on the loan. There are some benefits to using a personal guarantee, including potentially better interest rates. But it also means you’re putting your personal assets at risk if your business experiences a downturn and can’t make its loan repayments on time. Learn what a personal guarantee entails, what risks it involves, and what to know before you sign one for your next business loan.

What Is a Personal Guarantee?

A personal guarantee is a legal obligation that an individual will be financially responsible for a business debt if the business itself can’t repay the financing. If a business owner signs a personal guarantee as part of a loan agreement, he or she must cover the debt with personal assets in the event of the business defaulting. If you apply for a loan with this type of agreement, your personal credit history will be reviewed as part of the loan application process (and in addition to your business’s financials). As part of a personal guarantee, you may need to pledge assets. Typically, assets could include your checking and savings accounts, vehicles, and real estate (like your home). It’s important to know what’s included in the guarantee because it should name the assets at risk if the loan goes into default.Despite the risks to your personal assets, you may decide that it’s worth signing a personal guarantee. It can help strengthen your application, especially if your company has poor credit or no credit history.

Limited Vs. Unlimited Personal Guarantees

There are two primary types of personal guarantees: limited and unlimited personal guarantees. It’s important to understand the differences because your responsibility varies significantly depending on which type the lender requires.Limited guarantee. This option is usually designed when there are multiple business owners making the guarantee. Each owner is responsible for up to a certain percentage or amount of the outstanding balance if the loan goes into default. Five partners, for instance, might each have a limited guarantee of 20% of the loan balance.Unlimited guarantee. This type of guarantee requires one principal personal guarantor who is responsible for the full amount of the business loan. In addition to liquid assets, the creditor may also seize physical assets like cars or real estate in order to recoup a defaulted loan.

Why Do Lenders Ask for Personal Guarantees?

A lender may require a personal guarantee as an extra layer of financial protection in case the business is not able or willing to repay the loan. Without a personal guarantee, there aren’t many ways for the lender to be reimbursed for the outstanding balance, particularly if the business doesn’t have a lot of assets to liquidate. Having the option of this legal recourse through an individual reduces the lender’s risk of losing money on the loan. Some forms of financing (like heavy equipment financing, merchant cash advances, or invoice factoring) are inherently tied to some type of asset or receivable. That may give the lender more confidence that the borrowed funds will be repaid or could easily be recouped in some way. But your business, like many others that apply for a general loan, may not have collateral or sales transactions to secure a loan. Or you may decide it’s not in your company’s best interest to take on those types of financing structures, which can eat into profit margins. A business loan with a personal guarantee may help you qualify for a better structure and loan terms while still giving your lender extra security for the loan. It is a different financial arrangement than a personal loan.

Types of Business Financing That Require a Personal Guarantee

A personal guarantee is generally required for small businesses and startups. These businesses may not be fully established yet, so using an owner’s or partner’s credit can strengthen the application. And using debt financing secured with a personal guarantee allows you to retain ownership of your company rather than hand over a chunk of equity to external investors in exchange for funding.The following types of business financing typically need a personal guarantee.

SBA loans. SBA loans require an unlimited personal guarantee for any individual owning 20% or more of the business applying for a loan. That also means your personal credit score is reviewed as part of the loan application. There are multiple types of SBA loans, so you should explore them all to determine which is best suited for your needs.
Short-term business loans. There are many different types of short-term business loans, some of which do require a personal guarantee. These loans are typically used to help with cash flow issues or emergency expenses. You can often apply online and get quick funding if you qualify. Term loans are likely to be secured by a guarantee, so check your offer carefully.
Long-term business loans. These loans last anywhere between three and 10 years, or even longer if your business is making a major capital investment like real estate. Depending on the situation, you may be able to use business assets (like equipment or property) as collateral. But personal credit may also be considered as part of the loan application and a personal guarantee or blanket lien on the business could be a stipulation to qualify.

Secured financing (like heavy equipment financing or merchant cash advances) is less likely to require a personal guarantee. The downside, of course, is much higher interest rates and fees.

Benefits of Personal Guarantees

While a personal guarantee increases your financial responsibility for the success of your company, there are some benefits that come along with it. Most importantly, it can help your business qualify for financing for which it might otherwise not be eligible.A personal guarantee could also improve the conditions of your loan. While there’s an increased risk for you, you might receive a lower interest rate, a larger loan amount, or a longer payoff term. In fact, some business owners use a personal guarantee even when it’s not required just so they can take advantage of these benefits. The better your personal credit, the better the business loan terms you can expect.

Risks of Personal Guarantees

Signing a personal guarantee brings with it a significant amount of risk for the borrower. If the business defaults on the loan, legal action could be taken against you to repay the loan balance. You could lose your personal assets. But note that some states have homestead laws, which prohibit creditors from seizing your primary residence and retirement savings accounts.If things go badly for your business, the repercussions from signing a personal guarantee can harm both your business and personal credit scores. Plus, you may be responsible for the lender’s legal fees if it must take legal action in order to collect the debt. That amount is added to the whatever balance you have on the business loan, as well as your own legal fees. It’s difficult to get out of a personal guarantee before the loan is paid off. Business bankruptcy typically doesn’t get you out of a personal guarantee — only personal bankruptcy can do that. The personal guarantee may also stay in place even if you sell your business. That’s one more reason that it’s vital to understand the conditions of the guarantee in all possible situations. It’s a good idea to have an attorney review your loan agreement so you fully understand your responsibilities before you commit to the financing.

How Does a Personal Guarantee Affect Your Finances?

Signing a personal guarantee can have a major effect on your finances, but usually only if the loan goes into default. If your business is up-to-date on its loan payments, it usually doesn’t show up on your individual credit report. However, future personal loan applications may ask if you have a personal guarantee elsewhere. In this instance, you could limit your ability to qualify for other financing because of your increased debt-to-income ratio.If your business does default on the loan, that could show up on your credit report, as would any collections or judgment issued. Negative marks on your credit report typically last between seven and 10 years. The more severe the default, the lower your score will drop. This can impact your ability to qualify for financing for years to come. And if you do qualify, you’ll likely be subject to extremely high interest rates. Existing rates on your current credit cards can also increase when your credit score drops. The new APR won’t apply to an existing balance, but does affect new purchases.Finally, a personal guarantee that goes into collections could impact your spouse, too, if you don’t explicitly have joint assets excluded from the guarantee.

Alternatives to a Personal Guarantee

Lenders are likely to want some form of security to lower their risk when they extend loans to businesses with less than stellar credit or no track record. There may be options that can take the place of a personal guarantee in terms of allowing you to obtain better credit terms. Collateral. One way a company may be able to get better terms on a loan is by offering collateral. Collateral is an asset or set of assets that helps secure the loan and lowers the risk for the lender If the company defaults on the loan, the lender can claim the collateral for the debt owed. This may be a risk for the business, but doesn’t necessarily affect the owner’s personal property and/or finances directly.Blanket Business Lien. This is similar to a personal guarantee, except that it offers up not your personal assets but the business’s assets as security. If your business defaults on the loan, the lender is entitled to possess and/or liquidate your business's assets to fulfill your debt. Note that some lenders may require a personal guarantee in addition to a blanket lien, meaning that if your business assets aren’t enough to pay back what your business owes them, they can go after your personal assets, too. There’s another argument for reading the fine print carefully.

The Takeaway

A personal guarantee is commonplace in the world of small business loans. But it’s still important to understand the full scope of your responsibility so that you’re aware of the risks and sure that you’re willing to take them. Although agreeing to a personal guarantee is likely to improve the terms of the loans you qualify for, it’s good to know what’s on offer without a personal guarantee as well as with one. Before signing any business loan agreement, be sure to compare multiple offers. You can explore different lenders with Lantern Credit so you can find the best option available for your business.

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About the Author

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.

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