Key Points to Take into Account Before Becoming a Loan Guarantor

Getting a loan sometimes is not that easy. The lender might not be convinced by the borrower’s low credit score or if certain eligibility criteria is not met. In such cases, the lender asks for a loan guarantor, who offers the guarantee to pay back the amount in case the borrower defaults or vouches for the person’s credibility to payback.
 

If you have been approached by someone known to become a loan guarantor, make sure you know the following things. But first let us understand the basics first.

What is a loan guarantor and what are the responsibilities of a loan guarantor

A loan guarantor is a term used in finance to describe someone who agrees to repay someone else's debt if they default. A loan guarantee is basically an agreement between three parties: lender, borrower, and guarantor.

A loan guarantor can be anyone. They can be your spouse, parents, relatives, or friends. The prime condition for becoming a guarantor is the guarantor should have a strong credit profile. Let's take an example to understand the loan guarantor's responsibilities.

Assume your friend took out a Rs 5,00,000 personal loan with a 60-month repayment schedule. On his loan application, you become a guarantor. But, after paying the first 16 months' instalments, your friend defaults on his loan. In this case, you will be responsible for repaying the remaining dues. If you refuse to pay, you will face various undesirable consequences.

When do financial institutions ask to add a guarantor?

When you submit your application, your lender evaluates your profile and informs you whether or not you require a guarantor. Some circumstances when you can't receive a loan without a guarantor are:

• You have a poor credit history or credit score and previously missed a few EMI payments.
• If you are nearing retirement and the lender doubts your repayment ability.
• You change jobs regularly and do not have a consistent revenue stream.
• You fail to meet any other parameter of your lender's minimum eligibility criteria. 

Simply put, any single point that gives the lender the idea that you may default on a loan in the future necessitates the addition of a guarantor.

Top 5 Things to Consider When Becoming a Loan Guarantor

1. The type of personal loan guarantee you are giving

   There are two sorts of loan guarantors. The first is a financial guarantor, and the second is a non-financial guarantor. If you sign as the former, the lender will also assess your financial position. If the principal borrower defaults on a loan, you will be held liable. You should only sign as a financial guarantor if you are confident in the borrower's creditworthiness.

    

   However, there will be no repayment burden attached to your profile if you sign as a non-financial guarantor. You will only serve as a character or identity certifier. The lender will contact you if they fail to connect with the primary borrower.

Related Read: The top 6 reasons why should you apply for a personal loan
 

2. Primary borrower's credit profile

   Spend some time, just like the lender, learning about the principal borrower's profile before signing as a guarantor. If you intend to sign as a guarantor for a friend or colleague, this is what you should do.
    

   • Request a copy of their credit report from the credit bureau's website.
   • Also, obtain a copy of the bank account statement into which their salary gets credited and which they use to make EMI payments.
   • You can use the documents to compute their debt-to-income ratio. It will also reveal whether or not they are capable of repaying their debts.

   Main point to note: Avoid becoming a guarantor if you are not satisfied with their profile.

3. Impact on your loan eligibility

   A common question that is asked is - “does being a guarantor affect your credit?" The one word answer to this is YES. Here's how. 
    
   If you have plans to avail a large loan in future, avoid becoming a loan guarantor. Because if the borrower defaults, it becomes your responsibility to settle the unpaid dues as a borrower. Moreover, the situation impacts both your credit profile and budget. 
    
   The lender counts your obligations as a guarantor when applying for a new loan. The situation may reduce your eligibility significantly. And in the worst-case scenario, it will result in a higher interest rate, a smaller loan amount, and more stringent loan terms and conditions.
    

Also Read: 5 factors that affect your personal loan eligibility

4. Credit limit usage

   As soon as you become a loan guarantor, the credit bureau recognises the loan as a lien on your existing line of credit. As a result, your credit card usage limit, overdraft facility, and business line of credit might get reduced. 

5. Examine the reason

   Always try to understand why the lender requires a guarantor. It's time to reconsider your decision if they need the one because the principal borrower does not earn well or has an unstable income. In the same way, if the primary borrower is about to retire from their job, they are likely to lose their earning potential. Default is highly possible in such circumstances.

How to protect yourself as a loan guarantor?

1. Add co-guarantor

   If the loan amount is substantial and you are concerned about the borrower's ability to repay, ask them to add a co-guarantor. It will significantly lessen your liability and your risk of financial loss.

2. Beware of the clauses

   A loan agreement is full of clauses. But, you only need to be concerned about the clause related to the guarantor. Check the repayment clause of the following situation.

   • Death of primary borrower
   • Loss of income for the primary borrower
   • Consequences of the guarantor's failure to repay

3. Keep track of the payment

   Always keep track of how the borrower is repaying the loan. In case you notice any inconsistencies in EMI payment, do ask for a reason and try to work together to address the problem.

Can you remove your name as a guarantor?

It's difficult to remove your name as a guarantor. But, in some cases, the lender may permit you to withdraw your name. For example, if the loan is secured against insurance, you can approach the lender directly and inform them of your intention to withdraw your name as a guarantor. The lender may allow you to withdraw your name if the borrower is introducing another individual as a guarantor.

What are the disadvantages of being a guarantor?

• Being a guarantor impacts your future borrowing capacity. 
• It might lower your credit card limit. 
• If the borrower defaults and you fail to pay on their behalf, you may face legal action, and in the worst-case scenario, the lender may seize your asset and auction it off to recover their debt.

Also Read: A Step-by-step Guide to Getting Unsecured Personal Loans

To Conclude:

If you have been approached to become a loan guarantor, never be in a haste to sign on the papers. Make sure you have a thorough understanding of your obligations and the implications of failing to meet them. Also, do not forget to check on the borrower's creditworthiness, his or her income and responsibilities towards their family before signing the application. In short, always give a careful consideration to all possible reasons and context that has led someone to ask you to become a loan guarantor. If everything is fine, there is no problem in becoming a loan guarantor.

Frequently Asked Questions

How is a co-borrower different from a guarantor?

A co-borrower is jointly responsible for repaying the loan, while a guarantor is only liable if the primary borrower defaults. A co-borrower typically has access to the loan amount, whereas a guarantor does not.