Working in property? Why you need to be aware of Personal Guarantee?

Working in property? Why you need to be aware of Personal Guarantee?

Do you know what a personal guarantee is? If you are looking or want to be involved in property then you should be aware of what personal guarantee is, how it works and why you shouldn’t be scared of it.

A personal guarantee is a promise made by an individual or an organisation to accept responsibility for a loan or a debt. When you become established as a developer you will often find people in the industry having shudders down their spines at the thought of guarantee and this is something that I encourage you to eliminate.

Within the property space you may hear people talking about ring fencing property developments, putting them into a limited company and to a degree this is absolutely correct, and this does make sense. However, you can never avoid the responsibility of the debt that we are actually taking and its incredibly important that we act in a responsible way. Therefore, my view around personal guarantees is that it’s just one of those aspects that we have to do in property. And for me this has not really been a problem, I have never been caught out in any way at this stage.

What exactly is a personal guarantee?

A personal guarantee is your undertaking to cover a certain element of loss that the bank may have. There is more to it than just saying that I will offer personal guarantee. To provide a personal guarantee you need to prove enough assets to cover the cost of that guarantee. Generally speaking, a personal guarantee is around 20% of the total loan. For example, if you borrowed £1,000,000 then you need to prove that you can cover a guarantee of £200,000.

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Why is there fear associated with personal guarantees?

Many people are concerned and the thought of offering a personal guarantee worries them and I think its important to address this.

For example, if your bank agrees to lend you £1,000,000, they are not going to lend you 100% of the value of the site to begin with. They will be lending you around 60%-80% of the value. So that £1,000,000 loan is against something that is most likely worth £1,200,000 - £1,500,000. The first thing that happens is, if everything goes wrong, everything gets sold. As the property gets sold, the bank is only trying to recuperate that original £1,000,000. Therefore, if it gets sold for £1,500,000 it never becomes an issue anyway and there is always a margin of error which is intentionally created which is driven by the fact that the banks give you loan to value. Therefore, them personal guarantee never really needs to get looked at. It is only there in case of an ultimately worst-case scenario.

After all of this considered to offer personal guarantee, you must have enough assets to cover the amount. The best way to understand this is through understanding your assets and liabilities. You need to analyse your assets compared to your liabilities. Assets include things such as cash in the bank or a business investment and on the other side there are liabilities which include things like loans and credit cards. Once you have an understanding of both of these two things you then have a balance, which is your financial position and being in the property space you should always be aware of your finical position.

The reason that you should understand about your financial position is because your personal guarantee is based against your current financial position. It may be that you are taking out a £1,000,000 loan but you need a £200,000, guarantee but you don’t actually have enough NET position to be able to cover that and this is where partners come in. This could be your equity partner or your development partner who can work with you to help cover the equity requirement cost.

Something to note...

Personal guarantee doesn’t go anywhere, no money is taken from the bank. If you offer personal guarantee, then you will just sign a contract to say that you will cover it in the eventuality if something does go wrong.

Something important that you should be aware of in contract is something called JOINT AND SEVERAL. If there are 5 of you in the deal, you are all fully and equally responsible for the amount of that personal guarantee. However, in reality the lender will be perusing the partner who has the highest NET worth effectively.

This will never be an issue so long as you do your due diligence and work with property deals in a safe and sustainable way.

Key things to remember:
  • Don’t be fearful of personal guarantees.
  • Personal guarantee is 20%
  • It’s in contract form, nothing is taken from your bank
  • You need to understand the term, joint and several
  • You need to understand that you have enough asset to cover the personal guarantee

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