While friendships are overwhelming and we go to any length to be by a friend’s side, it might be worth remembering that money does have the power to sour relationships. At some point or the other, a friend or family member must have asked you to sign up as a guarantor to a loan. And all that is required is for you to sign on the dotted line in a loan application form.
However, it often comes with a lot of responsibility and increases your financial liabilities.
Let’s understand what it means for you.
When does a bank ask for a loan guarantor?
Banks and NBFCs typically ask for a loan guarantor when the borrower’s credit history is weak, financial position is weak or income is inadequate for loan eligibility. The reason that banks insist on a loan guarantor is to ensure that the money that’s being lent is recovered. So, make sure you have a clear understanding of the borrowing potential of your friend before you sign up as a guarantor.
There are broadly two roles a guarantor can play – as a non-financial guarantor and a financial guarantor. A non-financial guarantor has the responsibility to liaise between the bank and the borrower to resolve problems, such as delay in payments. A financial guarantor on the other hand may have the responsibility to cough up the loan repayment amount in case the borrower defaults.
How can becoming a loan guarantor affect you?
In case a borrower defaults on repayment of a loan, the lender first approaches the borrower in order to recover the dues. If the lender is unable to do so, it will contact the guarantor to settle the dues. If you, as a guarantor, do not pay off the dues, the bank is well within its rights to auction your property and recover the money in the worst possible scenario. Apart from this there are other implications.
Effect on your credit score
If you are a guarantor for a loan, your credit report will show that. Irregular payments and defaulting on loan repayment on part of the borrower can affect your credit score. Before signing up as a guarantor, you might want to check your credit score. If it is already low, you don’t want to expose yourself to further vulnerability by becoming a loan guarantor.
Effect on future loan eligibility
Once you become a guarantor for a loan, your eligibility for a loan reduces by the loan amount you stand guarantee for. This is because the loan liability can be shifted upon you at any point if the borrower defaults on the loan. So you should sign up as a guarantor only if you are sure of not wanting to take any loan in the near future.
Should you become a guarantor or not?
Signing up as a guarantor is a huge responsibility and is best avoided unless the loan is taken by your spouse, a close family member or a friend whose financial credentials and repayment capacity you are absolutely sure of.
If you have already signed up as a guarantor for a friend and you are not sure of his/her repayment capacity, you can step out of the role by approaching the borrower. However, the lender would have to find a replacement for you to be able to take your name off the loan.
The writer is CEO, BankBazaar. The article has been published in collaboration with BankBazaar. Opinions expressed are that of the author.