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A debt guarantee is an assurance that, should one party default on a debt or loan, the other party will pay. In order to provide such a guarantee, the party that would be responsible in the case of a default must agree, usually by also signing the loan documents. A debt guarantee is often used by those who have poor credit or no credit as a way of securing a loan, and possibly building or rebuilding credit.
In order to provide a debt guarantee, a person or entity must become a co-signer on a loan product. Typically, the co-signer is a person that has better credit, and is in a better position to repay the loan. The person offering the guarantee may not ever make a payment, but serves as the safety net the lender will depend on if the primary debt holder is no longer able to pay.
The most common debt guarantees are those associated with personal loan problems, but that is not the only situation where guarantees are provided. For example, one nation may provide a debt guarantee for another nation. If that nation defaults, then the other nation, or a group of nations, may provide payment for a period of time. In some cases, a government may guarantee a loan for a private individual, such as with student loans or home mortgages.
The benefit to the original loan holder is that if they have a debt guarantee, they may get a loan at a lower interest rate. Two individuals or entities promising to pay back the debt means there is less of a risk for overall default. That means the lender may be willing to accept a lower interest rate in return for less risk of loss. In some cases, the loan applicant may not even be able to get a loan without a guarantee, which is another benefit.
In some cases, a debt guarantee may not make it any easier to get a loan or better interest rate, but may allow an applicant to get a larger loan. This is especially true for some home mortgages. In these cases, the primary loan holder must still qualify on his or her own for a loan product. The debt guarantee only secures a larger loan than the person would ordinarily qualify for.
If a person wishes to no longer provide a debt guarantee, then the loan product must be refinanced. In such a case, the primary loan holder may need to find another guarantor, or may by that time be in a position to no longer need one. The primary loan holder must agree to refinance. If not, then the other party is still legally responsible, and may be adversely affected should a default occur.
Guarantees are often made for business debt, as well as personal debt.
Parent companies often guarantee debt incurred by subsidiaries, especially when the proceeds of the loan or other debt securities go in part to a company-wide project.
There are a few benefits for parent companies to guarantee subsidiary debt.
First of all, it is in the holding or parent company's best interest to ensure that all components of the company are running smoothly with as little default risk as possible.
In addition, many parent companies' only purpose is to manage the operations of subsidiaries. As a result, any funding needed for subsidiary projects and operating activities directly affects the bottom line for the entire business.
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