Sometimes when you offer a loan or credit to a person or business, you will have concerns about their ability to pay off their debt. Similarly, a landlord may be concerned that a tenant will default on rent payments.
When a creditor is concerned about a debtor's credit history or ability to pay a debt, or where the prospective debtor cannot qualify for credit, a lease or loan based upon the debtor's own income, assets and credit history, you may seek a guaranty of payment from another person or business. A guarantor is a person who provides a guaranty for the debt of another business or individual.
There are two basic forms of guaranty:
Guaranty of Payment - With a guaranty of payment, payment can be demanded from the guarantor even if the loan is current and the primary debtor has not missed any payments.
Guaranty of Performance - With a guaranty of collection or performance, you must attempt to collect the debt from the original debtor before you may ask the guarantor to cover the debt.
When extending credit, whenever possible you should seek a guaranty of payment. Although it is rare to demand payment from a guarantor without first requesting payment from the debtor, with a guaranty of payment you do not need to prove that you have made reasonable collection efforts or that a default has actually occurred prior to asking the guarantor to cover the debt.
With a guaranty of performance or collection, the guarantor can insist that you prove that a default has in fact occurred and that you have made a reasonable effort to collect the debt before you can obtain payment from the guarantor, meaning that obtaining money from the guarantor is likely to take more time and effort, and may be more costly.
When you require a guarantor for a loan or extension of credit:
Verify Creditworthiness - A guarantor should be financially sound, and able to repay the debt if the principal debtor fails to perform.
Get Proper Authorization - If the guarantor is a business, make sure that the appropriate decision-makers in the business have properly approved and committed to the guaranty, be they the principals or directors of the business.
If the guarantor is an individual, in order to reduce problems if you later have to collect against joint assets you may want to see if the guarantor's spouse will also commit to the guaranty. However, you must make sure that in doing so you do not violate the Equal Credit Opportunity Act (ECOA), which among other provisions prohibits discrimination against a participant in a credit transaction based upon marital status.
A guaranty is a contract, and should be in writing:
The Guaranty Should Be Personal - The guaranty should commit the individual or business to pay the obligation. Individual guarantors should sign under their own names, with no use of a title or other qualification that might suggest that the guaranty is not a personal obligation.
The Guaranty Should Be in Writing - An oral promise to pay is likely unenforceable as a promise to make a gift, under a provision of a state law (statute of frauds) that requires the promise to repay the debt of another to be in writing and signed by the guarantor, or both.
The Guaranty Should Be Witnessed - The guaranty should be signed in the presence of one or more witnesses, who can attest to the validity of the signature if the guarantor later denies signing the document. You may consider having the guarantor's signature notarized, with the notary verifying the guarantor's identity.
If you obtain a guaranty for a loan or extension of credit, be careful about your future negotiations with the debtor.
Any material change in the conditions of your contract with the debtor, including repayment terms, forbearance in response to late payments, or the extension of additional credit, could potentially affect the validity of the guaranty.