Guaranteeing a Loan – Things to know

Becoming a guarantor for a loan is a huge responsibility. It means you are providing a guarantee to the lender that you shall repay the debt of the borrower if s/he is unable to do so if such a situation may arise.

You have been magnanimous and become a guarantor of the loan that a friend or a close relative has taken, but after a while you decide that it has not been your wisest move and you want to opt out. If you don’t and the borrower becomes a defaulter on her/his loan you will be made equally liable for it. As a result, not only will the lender come after you, it will be a blotch on your CIBIL report and bring down your CIBIL score drastically. This, in turn means that if you do not pay up the outstanding, you will not get access to credit when you need it. Needless to say, that is a heavy price to pay.

Who can be a Guarantor?

Family, friend or colleague, becoming a guarantor entails a huge responsibility. So, banks will ensure you are able to bear that responsibility. Banks would check your credentials thoroughly on the basis of pre-determined criteria, such as income. Banks would also ask for details of your assets and liabilities along with copies of supporting documents. You would also have to sign a legal agreement.

Why do banks seek Guarantors?

Banks seek loan guarantors when the loan amount exceeds a minimum limit or if the income of the applicant is not eligible for the applied loan amount. In some cases, factors like the age of the applicant, low credit score, or profile of the applicant, call for a loan guarantor.

Things to consider before becoming a Guarantor

Banks do their due diligence regarding the guarantor as well. It’s wise that you do your bit before simply agreeing to fall for pressure.

1. It is important to be well-informed of one’s own financial profile, it is significantly important to understand the credit profile of an individual you choose to be a guarantor for. As a guarantor, you carry an obligation under conditions where the main applicant is unable to repay. This could leave a long-term impression on the guarantor’s credit worthiness, hence, it’s imperative to understand the persons financial and credit behaviour.
2. While undertaking a guarantee it’s not enough to know the person. Asking questions to do complete due diligence on the borrower is equally important. Understand why they need you as a guarantor and how do they plan to pay off the applied loan.
3. Consider carefully before agreeing to become a guarantor, and keep track of how many loans you are guaranteeing. This can impact your credit score, access to credit and eventually your financial goals. If you can’t say no when someone asks you to be their loan guarantor, remember you might just get into some serious trouble even if one borrower defaults.
4. Even if you are a guarantor to one loan, monitor your credit report and score regularly to check the loan repayment status and identify if anything is amiss.

Drawbacks becoming a Guarantor

1. You will have to undergo Credit Checks

As you guarantee for someone’s loan, you are taking the burden off their shoulders and save them from having to go through credit checks, but in return the check will be made against you. This means you will probably have to submit more paperwork than the actual applicant, including proof that you are financially capable of being their guarantor.

2. You are responsible if the Borrower Defaults

Probably the biggest risk that comes with being a guarantor is that you will have to take responsibility over the applicant’s actions and will have to suffer the consequences if they choose not to pay. This is because as a co-signer, you are legally bound to cover any of their shortfalls to the lender.

3. Affects Friendships/Relationships

How many friendships or relationships have broken over money? Be sure that the person you’re helping has high enough respect towards your relationship that they will never even think about turning their back against their obligation.

4. Future Loan prospects

Becoming a loan guarantor would significantly reduce your loan-taking capability. If someone is a guarantor on a loan, his own loan eligibility comes down than what it would have been if he wasn’t a guarantor.

What if Borrower Defaults?

If you agree to pay

You may need a loan to repay the amount. If you already have your own loans running, getting a new loan would be difficult. As a guarantor, if you repay the borrower’s loan by taking a home loan, you will not get any tax deduction nor will the borrower.

If you refuse to pay

Banks are a business entity and don’t like non-performing assets. Hence, they will go to every legal extent to recover the funds. If you are a guarantor, you are liable to pay the debt if the borrower defaults. If you do not pay, under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, banks can attach your property, auction it and recover the money. Banks may make a recovery decree to attach your movable and immovable assets. Worse, you could go to jail.

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