Twitter
Advertisement

Standing guarantee for loan? Beware of the consequences

In case of default by the borrower, the guarantor’s eligibility reduces to the extent of the loan amount. This is apart from shouldering the loan liability

Latest News
article-main
FacebookTwitterWhatsappLinkedin

Proverbs 22:26 of the Bible says, “Don't promise to be responsible for someone else's debts”. And this age-old financial advice still stands true even today.

On August 15, the Supreme Court of India ruled that banks should act against guarantors even as proceedings under Insolvency and Bankruptcy Code are on. This was with reference to corporate loans. But what if it’s a family member or a close friend asking you to become their loan guarantor? Many times it is simply difficult to refuse.

Rajan Pental (Group President and Group Head - Branch and Retail Banking at Yes BANK said, “Any loan that needs to be secured by more than mere cash flow of the primary borrower, may need a guarantee such as loan against property, working capital facilities for SME etc.”

In fact, many public sector banks ask for loan guarantors on education loans beyond certain amounts. Sachin Chaudhary, COO, Indiabulls Housing Finance said, "Home financing companies typically only require a guarantor against an applicant in select cases, such as, the lack of a co-applicant, high-risk applicant profiles or weaker financial strength.”

This means if your family or friend is asking you to be a guarantor on a housing finance company loan, you should probably double check the borrower’s repayment capacity before agreeing to be a guarantor. Chaudhary added, “It is advisable to only become a guarantor when one is absolutely confident of the applicant’s credibility and ability to pay back the borrowed sum".

Impact on credit score

If you think that being a guarantor is simply about signing a dotted line for a family or friend, think again. Pental said, “One should be cognizant of the fact that the guarantor shares equal liability for repayment of the loan and that in case of default by the primary borrower, it shall be the responsibility of the guarantor to clear all dues to the lending organization.”

In short, your financial life stands at risks, so does your credit score. Sujata Ahlawat, Head of Direct to Consumer Interactive TransUnion CIBIL said, “Banks and financial institutions ask for a guarantor for certain loans as a means of security for the loan amount they provide. The guarantor is equally responsible to ensure repayment of the loan, and guarantees the lender that he will honour the obligation in case of non-payment by a borrower. Missed payments will not only reflect in the guarantor's credit report, but will have a negative impact on their credit score too.”

Remember the borrower’s, as well as your, credit reports will mention that you are a guarantor. Vaishali Kasture, Managing Director and Country Head, Experian India said, “Being a guarantor, one is legally responsible for the borrower’s debt. When lenders share information on the loan performance, details of guarantors are also shared along with that of the main borrower. These details automatically get reflected on one’s credit report along with the complete credit history. In case of non –repayment, the guarantor’s credit score is also affected along with the primary borrower, as this non-repayment is also reflected in his/her credit report. A low credit score will impact and cause hurdles while applying for loan in future for both parties.”

This means in case the borrower defaults; your credit score takes a hit and, hence, hurts your future loan eligibility. But, that’s not all, whenever you agree to become a loan guarantor for someone, your loan eligibility actually gets reduced. After all when you are a guarantor for someone, the bank usually reduces your eligibility to the extent of guarantee you’ve stood for since that liability can be shifted to you in case of default by the original borrower. 

Pental said, “For approving someone as a guarantor, Banks usually appraise the guarantor for credit worthiness, reputation, net worth and relationship of guarantor with borrower.”

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.

Firstly, remember while 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. Kasture said, “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.”

Secondly, 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.

Thirdly, Ahlawat said, “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.

Fourthly, 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.

Kasture said, “Have a clear understanding of the motive behind the credit undertaking. Research and read around his/her past credit behaviour.”

And, urge primary borrowers to monitor their credit report and score, too, and reduce over-leveraging of their credit limits. This will help them keep track their credit exposure and verify correct loan repayment information in their reports.

If the borrower defaults, the banks would first try and recover the debt from the borrower. But, if that doesn’t work, the guarantor will get a notice next. As the guarantor, you can ask the bank to sell the primary borrower’s property and recover the dues. Or you can pay the dues to save the property. But if you don’t have the required funds, you may even have to take a loan for the same.

Hence, it makes sense, to avoid such huge financial liability, even at the cost of sounding rude to a family member or friends. 

BEFORE YOU LEND A  HELPING HAND

  • In case of default by primary borrower, it is the responsibility of the guarantor to clear all dues 
     
  • In case of non–repayment, guarantor’s credit score is affected along with that of the primary borrower, as it is also reflected in the guarantor’s credit report 
     
  • It is important to understand the credit profile of an individual you choose to be a guarantor for 
     
  • As a guarantor, monitor your credit report and score regularly to check the loan repayment status and identify if anything is amiss
Find your daily dose of news & explainers in your WhatsApp. Stay updated, Stay informed-  Follow DNA on WhatsApp.
Advertisement

Live tv

Advertisement
Advertisement