At some point in your life you might encounter a friend, a relative, or a business partner who may ask you to become a loan guarantor, it is difficult to refuse and it is good to stand by the people you like and love. It is also good to help out friends in need. A friend in need is a friend indeed is a worldview that may get you into trouble if you are not careful in your financial dealings. Being a close person, you might accept to do the same without even realizing your own liabilities. Before you sign on the dotted line, do a reality check, know what it brings about and whether you are comfortable with it.
Who is a guarantor?
A guarantor is a person who agrees to be legally liable to pay off the loan, in case the primary applicant is unable to do so for whatever reasons. Not like in case of a co-borrower, a guarantor does not need to be a close family member of the primary borrower. The guarantor is always asked to co-sign the loan agreement before it goes through and the lender will ask both the persons to go over the terms and conditions of the agreement.
There are generally two roles that a guarantor play. A financial guarantor could have the responsibility to handle the loan payments in case the borrower defaults. But a non-financial guarantor has the responsibility to act as a network between the bank and the borrower to resolve problems such as delays in payments.
As the number of loan defaults rising, it has become necessary to understand the consequences of being a guarantor. The guarantor must fully understand the roles and responsibilities involved in the transaction. It is like agreeing to the fact if the actual borrower does not pay, you will.
When do banks ask for a guarantor?
Banks can ask for a borrower to provide guarantors in different cases. Some of the most common cases are:
- If the amount to be borrowed is beyond a certain limit as per bank policies
- If the applicant has very weak financial standing, i.e. a low credit score
- If the applicant’s credit history is not particularly clean, i.e. credit card/previous loan debt settlement
- If the primary borrower is of an advanced age
- If the applicant is self-employed or earns less than a pre-determined minimum income level
- If the applicant works in a high-risk profession
- If the applicant has an Unstable income which brings a big cloud of doubt when it comes to repayments
- As part of the bank’s policy requirements
- Unstable employment with repeated transfers to different cities
- Job stability is a concern
- Poor academic background
The above are only a few reasons why a bank might decide to ask for one or more guarantors and they are applicable to various classes of loans, including education loan, home loan, personal loan, or any other loan where the amount borrowed is high.
Things to Note before You become a Guarantor:
If you are signing up as a guarantor for someone’s Loan, here are five things you should consider.
What your liabilities are as a guarantor?
The main reason why banks ask for a guarantor is to ensure that the amount of loan lent is recovered. Though being a guarantor is different from being a co-borrower, from the bank’s point of view, you have an equal legal responsibility to pay off the loan. Thus, when signing up as a guarantor, you are required to submit key documents such as assets, income proof, and liability information, etc. The bank uses these documents to verify if you are eligible to act as a guarantor for the loan that means the bank would check if you have the financial means to pay off the loan in case the primary applicant defaults. Therefore, make sure you know the reason why the borrower is being asked to get a guarantor. You must also ensure that the borrower is capable of repayment before you sign as a guarantor unless you are prepared to undertake the liability of repayment. The obligation of a guarantor is usually limited to repaying the outstanding loan along with any interest and late fees due, in case the lender fails to recover the loan amount.
Impact on your Credit Report:
When you sign up as a guarantor you risk your own Credit Score if the borrower defaults, it will show up on your credit report and therefore erode your credit score. Even delayed/ irregular payments by the borrower can affect your credit score. In addition, your eligibility for new loans will also reduce as banks will consider the loan you have guaranteed when determining your eligibility. Hence, you may be denied a loan, offered a lower loan amount or a loan at a higher rate of interest for just because of being the guarantor of an outstanding loan. Furthermore, in case you are already a guarantor for one or more outstanding loan, you might not be allowed to act as a guarantor for another.
Your own loan eligibility will be reduced:
Becoming a loan guarantor would decrease your loan-taking capability. If someone is a guarantor on a loan, his own loan eligibility worsen. As far as credit histories are concerned, any late payments or defaults made against the mortgage by the borrower will have an impact on the guarantor’s credit score, making her or him look financially unstable. Though a guarantor is responsible for a loan, generally on a secured loan, like a home loan, the bank will try to sell off the security to recover the loan amount. So, if you are planning to take a home loan for yourself, think twice before signing up as a guarantor.
What is the tenure of the loan?
Being a guarantor, you will be tied to the Loan until it is fully recovered. Once the repayment is done in full, the guarantor will need to request a no objection certificate (NOC) and a release of guarantorship from the lender to complete the process. If you are planning to become a Home Loan guarantor, you should know its repayment term-as nowadays, Home Loan can have a repayment tenure anywhere between 5 to 30 years, depending on the borrower’s capacity to pay, age, and other criteria.
Relationships get spoiled:
In case you are the guarantor of a loan whose borrower has defaulted, the bank will first try to seize the primary borrower’s assets to recover its money. Then, the lender will meet you as you are a guarantor and ask you to pay off the outstanding amount. In case you are unable to service the loan to the bank’s satisfaction for any reason, the bank can legally liquidate and seize your personal assets to recover the balance amount. This can destroy guarantor and borrower’s relationship. If you feel that the borrower is not that responsible to make the payments, don’t sign up as a guarantor. Make a rational choice in order to save your relationship with the borrower. Staying away from such huge financial liability even at the cost of sounding rude to a friends or family member makes sense. You do not want to disorder your financial life just because someone hasn’t repaid the loan. There is nothing to be defensive about. Instead, offer help in finding a better salary job or improving credit history. Bank processes do not work on trust and they do not work on emotions.
Hence, the role of a guarantor is not the one that you should take lightly. Do not become a guarantor unless the loan is for your child or spouse. If you are already a guarantor of a loan but are not sure about his/her repaying capacity, you could ask the borrower to release you from being a guarantor. But that can happen only if he finds another guarantor. Unfortunately, you cannot approach the lender to cancel your guarantee, only the borrower can initiate this request. Also, some banks do not allow changing of the guarantor. So, if you want to help your near and dear ones in need, being a loan guarantor comes at a risk, and hence, should be given a serious thought. In case you decide to become a guarantor of a loan, make sure you read the loan agreement carefully to understand the extent of your liability before signing the documents.