A loan guarantor is an individual who guarantees to repay a borrower's debt if the latter fails to repay it. Lenders typically ask for a guarantor if the borrower's income or credit rating barely meets the loan requirements, the loan amount is high, or the repayment tenure is long. If you agree to become a guarantor, the borrower's loan approval chances may increase. However, as the guarantor, you should brace for impact if the borrower defaults on the payment. Before agreeing to be one, consider these pros and cons of being a guarantor.
Role of a Loan Guarantor
As a guarantor, you must sign a legally binding agreement – a guarantee stating that the borrower will repay the loan within the stipulated tenure. The agreement further states that you, as the guarantor, would be held liable under Section 128 of the Indian Contract Act; that you would repay the debt on the borrower's behalf, including the interest and any penalties associated with the loan.
Impact on credit score
While serving as a loan guarantor for a high amount loan, you are not only entering a legal contract but also assuming the risks associated with loan defaulting on the borrower's behalf. For instance, if the borrower fails to repay the loan EMIs on time, it can affect your credit score and credit rating. Your credit score could fall, thereby impacting your borrowing capacity. Note that lenders seldom inform guarantors of irregular repayment by the borrower. So, you might not know the reason for your low credit rating.
You can read more about why a credit score matters by clicking here.
Other risks of going guarantor
Being a loan guarantor is a massive responsibility you should enter into only if you know the borrower well enough to put your own financial credibility at risk. Here are some other risks of going guarantor that you should know.
- It affects your loan eligibility
When you stand as a guarantor, the borrower's liabilities become your liabilities. When you apply for any loan, lenders can see that you are a loan guarantor on someone's debt and may reduce your loan eligibility. - You could face legal action
If the borrower is unable to pay their dues for any reason, including disability or death, the lender has the right to retrieve the payment from the borrower's guarantor. You could face legal action for refusing to comply with the lender on this matter. - Difficulties in exiting the contract
Unless the borrower finds a new guarantor or pledges collateral, it is nearly impossible to withdraw your name as the loan guarantor. Also, you have to undergo several approvals before the lender allows you to be free from the legal contract.
Things to remember
Before you agree to be a loan guarantor for your anyone, consider the following points:
- Check the borrower's financial health: You must evaluate the borrower's financial books before agreeing to be their guarantor and only sign up if the books are clean.
- Read the agreement thoroughly: Read the fine print thoroughly or have your lawyers assess the loan guarantor agreement before signing it. Ensure you understand the clauses pertaining to the borrower's defaults or demise.
- Keep a tab on the borrower's repayment habits: Ask the borrower to inform you each time they repay their EMIs and proactively check in with them after their EMI payment date.
- Opt for a co-guarantor: Agree to take on the responsibility of a guarantor only if the borrower can bring in a co-guarantor. Doing this will lower your financial risk to some extent.
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*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. Personal Loan at the sole discretion of HDFC Bank limited. Loan disbursal is subject to documentation and verification as per Banks requirement.