Posted in Finance, Accounting and Economics Terms, Total Reads: 388
A guarantor is a person who takes up the obligation of paying back a person’s debt (or) loan if he/she defaults on the same. In legal terms, a guarantor is bound to pay the creditor the claimed amount if the principal debtor (borrower) fails to do so.
Bank and other lending agencies usually ask for a guarantor when they sanction loans to individuals or firms. This is usually done to ensure payment of the loan when the borrower defaults on it. A guarantor is liable to the same extent of amount as that of the principal debtor and if the principal debtor pays back the loan by himself/herself, the guarantor is released from the contract.
Types of Guarantee:
Some of the different types of guarantee are:
• Personal Guarantee
• Financial Guarantee
• Performance Guarantee
• Rental Guarantee
Personal guarantee is a common form of guarantee that is usually asked for by banks when granting housing or vehicle loans to individuals. In this case, a relative or a personal friend of the borrower signs up as a legal guarantor for the loan.
Financial guarantee is usually given to a firm that is procuring material from a supplier. The guarantee indicates that the buyer will pay for the goods as and when they are received at his/her end. A rental guarantee is also similar wherein a guarantor assures payment of rent by the party in question.
A performance guarantee on the other hand is to guarantee “completion of work” by an entity. This is mostly seen in case of large-scale projects undertaken through SPVs (Special Purpose Vehicles). For example, when an oil company gets into construction of a new refinery, it may avail a large loan from a global institution like World Bank. In order to ensure completion of the refinery by the stipulated time (which leads to cash flows from the project that would be used for loan repayment), the World Bank can ask for a performance guarantee from a local bank or some other reputed refinery company.