How to spot risky loan guarantors and protect yourself as a lender

Lending money should never be a gamble. As a lender, you  need assurances that the loans will be repaid and you can protect your lending business.

Typically, when a borrower applies for a loan, you would assess their credit worthiness, financial capacity, and all other information relevant to deciding if they are good for the money. Sometimes it’s not enough, so you request for a collateral. But, when the borrower doesn’t have an acceptable asset you can hold on to for security, that’s where a guarantor comes in.

In the US and Canada, a loan guarantor is called a co-signer. A loan guarantor is basically like a backup plan.  They’re someone who says, “Hey, if this person defaults on the loan, I’ll step in and pay it off.” 

Sounds great in theory, doesn’t it?  But not so fast. Here’s the thing…

Don’t be fooled – a loan guarantor is basically like a secondary borrower.  You might not want to go after them for the money, but if the original person bails, the guarantor better be ready to pay up.  If they can’t, then having them as a guarantor was pointless.

This means you must subject the guarantor to the same level of credit worthiness check as the main borrower. This means there are as many risky guarantors as we have risky borrowers.

We’ll share effective ways to spot risky guarantors and protect yourself as a lender. But first, let’s look at those glaring red flags that make risky loan guarantors.

Mismatched financial capacity

Risky loan guarantors are people whose station in life and cash flow does not match up to the primary person they are trying to guarantee. In the best case scenario, anyone trying to be a loan guarantor must have a better financial capacity and creditworthiness  than the borrower they are trying to guarantee.

Reluctance to go through credit checks

A loan guarantor who doesn’t want to subject themselves to the same principles you use to score your customers is a major red flag. They might be hiding a bad credit history, which means they wouldn’t be able to repay the loan themselves if needed. A responsible loan guarantor understands that checking their credit is a normal part of the process.

Sketchy information and lack of payment method

If a potential guarantor provides vague or unverifiable information about where they work or their financial situation, or they hesitate and refuse to provide a way to pay you back (like a credit or debit card), that’s a major red flag. It’s a high level of risk because they may be intentionally hiding information or simply don’t have the money to cover the loan if needed.

Here are 5 ways to make sure your guarantor game is on point.

Mirror the borrower’s checks for the loan guarantor too

Treat your loan guarantor’s information with the same diligence you apply to the primary borrower. You must thoroughly check their credit score, validate that they actually work where they say they do, and confirm they have the ability to pay the loan if needed.

Formalize the agreement with them

Make sure the loan guarantor co-signs the contract that you have with the borrower. So if your customer is taking a million naira loan from you, they must co-sign a document that reads “I hereby guarantee the borrower”. This agreement is legally binding and solidifies their commitment to repay in the event that the borrower defaults on the loan.

A next of kin is NOT a loan guarantor

Knowing a borrower’s next of kin can be helpful for contacting them in case of an emergency, but it doesn’t mean they’re financially responsible for the loan. A loan guarantor, on the other hand, is legally obligated to step in and repay the debt if the borrower fails to do so. Never confuse the roles of a next of kin with a guarantor.

You must secure a payment method from the loan guarantor

Ask the guarantor to provide a way to collect payment easily if they become responsible for the loan. This could be a debit card, pre-signed checks, or another convenient method.

Keep communication open and transparent

Keep your loan guarantor informed about the borrower’s loan status. Copy them on email updates and any important correspondence relating to the repayment process.

Choose your loan guarantor wisely

Having a loan guarantor can provide extra security for your loan business, but only if you choose wisely. Watch out, like a hawk, for people with worse financial circumstances than the borrower, sketchy backgrounds, bad credit histories, with cheques that bounce and other unreliable payment methods.

Choose your loan guarantor wisely by verifying their identity and information thoroughly, get their signature on paper, securing a payment method, and keeping them abreast of all communications with the borrower. Your loan business depends on it.

If you’d like more support on how to manage your loan business with Lendsqr loan management software, send us a message at [email protected].