Guarantor Loans – A Cheaper Way of Borrowing?

Guarantor Loans – A Cheaper Way of Borrowing?

Over the years there has been a lot written in the media on the cost of payday loans. In the UK the result was government regulation that put many payday lenders out of business and radically transformed the industry. For consumers there is another alternative – the ‘guarantor loan’ that can be far cheaper in the long term than taking on a payday loan.

Interest rates and risk

Bank of England interest rates are still at historical lows, and for those with a very good credit history this can mean extremely cheap borrowing. Moneysupermarket.com say that with a very good credit history someone can borrow up to £7,500 for as little as 3.3%.

Lenders will charge more interest on a loan depending on the level of risk they see in the borrower. This is why payday lenders used to charge rates in excess of 1000% annually. They did not check borrowers’ credit history and instead assumed every borrower was a very high risk borrower.

Regulation on payday lenders has led to far lower interest rates but these can still be in the region of 277%. Paying nearly three times the amount borrowed in interest rates can be off-putting for the potential borrower and can lead to people getting in financial trouble in the long term.

A way forward

Borrowers who need the money yet who have a poor or underdeveloped credit history can now seek a cheaper, alternative route to borrowing money without paying excessive interest rates. Guarantor loans accept that the borrower themselves may have poor credit history but insist that the borrower has a verified guarantor with a good credit history.

The guarantor will often be a family member or close personal friend who is willing to make the loan repayment should there be problems in honouring the debt. During the assessment process of arranging a loan, the loan company will contact the guarantor and discuss with them their own credit history and commitments. This is to establish that the guarantor can pay the loan should the borrower default. While for the guarantor this can be a huge responsibility it does reduce the risk of the loan and guarantor lenders can therefore charge far lower interest rates than their competitors in the payday loan sector.

Leading guarantor lenders Buddy Loans for example can charge 41.6% APR over the period of an 18 month, £1500 loan. This vastly reduces the cost of the debt taken on and can allow people to repay their debt far more quickly than those taking out a high risk loan.

If it goes wrong?

If for whatever reason the borrower is late making a payment the lender will contact the guarantor and get them to press the borrower to make the repayments. This has been shown to be a lot more effective than a call from a subprime loan call centre. Ultimately the guarantor’s own credit score will be at risk should the contract not be honoured.  Given that the lending contract expressly states that the guarantor will have to make repayments should the borrower default, this ensures that the money will be returned.

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