Personal Guarantees: How Do They Work?
A personal guarantee on a business credit card is a liability agreement that the borrower will repay the debt associated with their business credit line.
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What Is a Personal Guarantee?
Personal guarantees are agreements between the owner of the business credit card and the issuing credit card company. The signer, typically the business owner, agrees to become a guarantor on a line of credit. The responsible party (or parties) guarantees repayment from personal assets even if the business entity can no longer meet the loan terms. Understanding how this works is essential for business owners to make wise decisions about their finances and know how to draw the line between their personal and business accounts.
How Does a Personal Guarantee Work on Business Credit Cards?
Business credit cards are revolving lines of credit granted to a business entity. They work similarly to personal credit cards in that there’s a limit, an interest charge and other fees. However, lenders often require a personal guarantee from applicants to apply for a business credit card.
A personal guarantee ensures the owner is liable for all debts incurred on the card should the business fail. Fortunately for the lender, this agreement reduces their risk, especially if they lend to a new business.
Collaterals in a Personal Guarantee
Before signing a personal guarantee, the lender and the borrower will set terms that dictate what will happen if the business defaults. Depending on the terms, the business owner may have to put up an asset or multiple assets as collateral. This can be a car, house or other real estate property. If the business entity can no longer make payments, the lender has the right to take any pledged assets to make up for the loan's outstanding balance.
Building Your Business Credit Score
While it may seem troublesome to have business owners pledge their personal assets for the sake of a business credit card and potentially lose those assets, the long-term benefits can be worth it for some. A business credit card is essential to building the business entity’s credit score, as the owner’s personal credit score will not carry over.
Types of Personal Guarantees
When laying out personal guarantee terms, business owners will come across two types: limited and unlimited. Understanding the difference between the two can help owners determine which kind of guarantee suits their situation best.
Limited Personal Guarantees
A limited guarantee is a predetermined amount the owner will pay, usually expressed as a percentage of the remaining debt. A limited personal guarantee benefits businesses with several owners who can split the responsibility. For instance, a limited guarantee can be divided between four owners, amounting to 25% of the outstanding balance each.
Unlimited Personal Guarantees
An unlimited guarantee means that the owner will be liable for the debt in its entirety. If collateral was put up, the lender would have the right to seize the asset to repay the outstanding balance. If the collateral is insufficient to cover the debt, lenders may go after the owner's other assets, even if it was not specified in the personal guarantee.
Other Uses of Personal Guarantees
Aside from serving as collateral for business credit cards, a personal guarantee can be used for other lines of credit. This allows business owners to leverage their personal credit to grant them more funding opportunities for their business.
Business Loans
A personal guarantee can help with securing a small business loan. With a personal guarantee, small or newly-established business owners can leverage their personal assets to get funding for their business.
Property Mortgages and Leases
If a business entity is trying to purchase or lease a property, the business owner can use a personal guarantee to ease the worry of the landlord or seller. This can even help the business owner get more favorable terms.
Asset Leases
A personal guarantee can be used as collateral when leasing assets. Leasing an asset can help small businesses leverage equipment or property crucial for their business, such as manufacturing equipment or automobiles.
Guaranteeing Another Person’s Debt
A personal guarantee can be used to guarantee someone else’s personal or business-related debt. If the guarantor is not the borrower, the guarantor will be on the hook if the borrower cannot repay the loan. The lender can legally seize the guarantor’s assets per their agreement. Guaranteeing another person’s debt is a serious obligation and comes with significant risks.
Benefits and Drawbacks of Personal Guarantees
A personal guarantee can create business opportunities for a business owner and increase their line of credit, but it also has drawbacks. Business owners must understand the pros and cons of a personal guarantee to determine if such lines of credit are a wise choice for their long-term goals.
- It can help improve a business’ application for a line of credit.
- It grants opportunities for businesses to apply for funding they may otherwise not have access to.
- It allows businesses to build their credit score in the long run.
- It can help with having access to favorable interest rates.
- It poses a risk to the guarantor’s personal assets and financial standing.
- If the debt is not repaid, it can have long-term consequences, such as bankruptcy and a lower credit score.
- It can cause mental health challenges due to the stress of needing to repay the line of credit.
If you’re considering getting a business credit card, MoneyGeek has examined the best credit cards for business owners. The top two include:
Review our in-depth analysis of each card to see which one suits your business needs.
Personal Guarantee FAQ
Learn the ins and outs of a personal guarantee through MoneyGeek’s frequently asked questions below.
Expert Insights on Personal Guarantee
A personal guarantee can be tricky for new business owners. We’ve asked the experts what to look out for and consider before entering this arrangement.
- Is it possible to get business credit (for a new business) without a personal guarantee?
- Are there ways for borrowers to limit the effects of a signed personal guarantee?
- What are some “carve-outs” in a personal guarantee that borrowers should watch out for?
Founder and CEO of Austin Real Estate Brokerage
Owner of Senior Home Transitions
CEO of The Kaplan Group
Related Content
If you’re a business owner and want to take more control of your business’ finances, take a look at some of MoneyGeek’s related pages below.
- Business Line of Credit: Learn what a business line of credit is and how it works.
- Business vs. Personal Credit Cards: What’s the Difference?: Understand the difference between a business credit card and a personal credit card. Consider the advantages of having both cards and keeping business and personal expenses separate.
- Business vs. Corporate Credit Cards: What’s the Difference?: Find out the difference between a business card and a corporate card. Evaluate which one works for you.
- Unsecured Business Loans: Learn what unsecured business loans are, how they help and how to qualify.
- Funding Your Startup: If you’ve just started your business and need capital but don’t know where to start, start here.
About Nathan Paulus
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