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The Personal Guaranty

Article | April 15, 2019

Often misunderstood, misused and problematic down the line, here’s everything you need to know before signing a personal guaranty.

The personal guaranty: it’s often misunderstood, misused, and frequently causes a problem down the line. When you apply for a commercial loan, you will be asked by the bank to sign a personal guaranty. It’s standard practice these days. After all, the bank is taking a risk on you.

A personal guaranty backs the commercial loan with additional collateral that satisfies the requirements of the bank. In a nutshell, if you default on the loan, the bank can come after all your personal assets, from your home and car to your investment portfolio and personal savings. Even the cash value of your insurance policies, notes you may owe others, and your kids’ college funds are up for grabs. The gist: Notes owed by the borrower are not an asset; it is a liability. However, notes to the borrower are an asset that can be taken in default.

The reality is two-fold: Of course, the bank needs collateral in case you default. However, they’re also doing something much more subtle. By signing a personal guaranty, they know you will do everything in your power to pay off that loan. They have you where they want you. In essence, if you don’t honor the contract, your house is at stake and your family could be on the street.

That’s the emotional win the bank achieves with a personal guaranty.

Be Prepared

It’s important to be prepared. How? Don’t own your home. You’re entering the high-risk small business arena where failure is not only common but anticipated. Everything you own, including the equity you’ve built up in your home, is at stake.

Only 80 percent of small businesses survive the first year; 50 percent will fail within the first five years, according to Forbes. It’s too much of a risk to gamble everything — especially when you don’t have to.

Instead, transfer ownership in your property to your spouse, essentially taking it out of the risk pool. This way, you’re limiting exposure of what is guaranteed.

If your spouse is a co-owner and not a signer of the loan, their half of the equity in the asset is protected.

Let’s say you and your spouse own your home and you sign a personal guaranty for a commercial loan but your spouse does not. Let’s say the loan goes into default and you know you have $100,000 in equity. The bank threatens to take all that equity or sell your home at auction. Well, they can’t take all the equity: only $50,000. That’s because your spouse didn’t sign the guaranty. Therefore, half is protected.

Now, that being said, the banks will do everything they can to convince you that they need your spouse’s signature on the personal guaranty. Don’t be fooled. If they can convince both of you to sign, they’ve eliminated that 50 percent buffer and can get all the equity in the house. Your whole house is now at risk.

The bank cannot make your spouse sign a personal guaranty. Doesn’t mean they won’t try. If they keep insisting, go to another bank.

Rules to Protect Yourself

Rule #1: Pre-Plan and Limit Asset Exposure

Recognize that a personal guaranty covers EVERYTHING you own. Take a long, hard look at your asset base and pre-plan. Put your house and all other major assets into your spouse’s name.

Rule #2: NEVER Have Your Spouse Sign a Guaranty

Despite what the bank says, it’s not a requirement of an SBA loan. Call their bluff and shop banks.

Rule #3: Never Guarantee Someone Else’s Loan

This includes a child’s loan, a grandchild’s loan, a relative’s loan, or a friend’s loan. The risk is too high and the consequences are too severe.

Bottom line is, virtually every commercial loan will have a requirement for a personal guaranty. You can’t change that. What you can change is how you react.

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