Recently, a few people posted on social media about getting fraudulent calls from someone posing as a bank official, who asked them to pay up a loan against which they had signed up as guarantors. These people didn’t have to pay anything as these were fraudulent calls, but what happens if you actually become a guarantor to someone else’s loan? Are you liable to pay back the loan if the original borrower defaults?
The ongoing cash crunch due to covid-19 has increased many people’s liabilities. Understand that becoming a guarantor can add to it.
Who is a guarantor?
Lenders generally ask borrowers to bring in a guarantor when the loan amount is high or if the bank is not comfortable with the repayment capacity of the primary borrower.
“The guarantor takes the responsibility that if in any scenario, the primary borrower fails to pay the equated monthly instalments (EMI) of the loan, then the guarantor will assume full repayment responsibility,” said Aditya Mishra, founder and CEO, Switchme.in, a platform that helps borrowers shift their home loans to other financial institutions.
Any person can be a guarantor but generally, close family members sign up for it in case they meet the lenders’ eligibility criteria. “A person becoming a loan guarantor has to satisfy the credit eligibility criterion applicable for the loan applicants, which means his credit profile has to suit the lender’s loan eligibility criterion,” said Aggarwal.
The bank will check and ask for all documents supporting the repayment capacity of the guarantor. “The guarantor is a kind of borrower who is not paying EMI on a regular basis but as soon as a default happens, he comes into the picture. So all know your customer (KYC) and income documents need to be submitted to check the eligibility of the guarantor,” said Mishra.
In case the primary borrower defaults on loan repayment, the liability to pay the outstanding amount falls on the guarantor of the loan. “In case of a default, the loan guarantor will become liable for timely repayment of the outstanding loan amount along with the penal rates and charges incurred due to non-payment of the loan,” said Gaurav Aggarwal, director, unsecured loans, Paisabazaar.com, an online marketplace for financial products.
In case of non-payment, a guarantor is liable to legal action. “If the lender files a recovery case, it will file the case against both the borrower and the guarantor. A court can force a guarantor to liquidate assets to pay off the loan,” added Mishra.
Even if things don’t go wrong, there are other downsides to deal with as a guarantor.
The moment you sign up as a guarantor, your own loan eligibility will come down. In case you apply for a loan, lenders will consider the outstanding amount on the loan for which you are a guarantor as your contingent liability and may extend credit to you accordingly.
“Guaranteeing a loan will reduce the overall loan eligibility of a loan guarantor by the outstanding loan amount of the guaranteed loan. So, one should always factor in his own credit requirements before agreeing to become a loan guarantor,” added Aggarwal.
Besides, the fact that you are a guarantor to a loan will also figure in your credit report. This also means that any default, either by the primary borrower or you, will affect your credit score.
What you should do
It may difficult to wriggle out from signing up as a guarantor in case a close relative is involved. However, it is important to assess the repayment capacity of the primary borrower before you agree to it. “As a risk mitigation measure, make sure that the loan applicants are financially disciplined and stable enough to make regular repayments before agreeing to become their loan guarantor,” said Mishra.
Even after you have signed up, keep an eye on the loan. “Existing loan guarantors can see their credit report at periodic intervals to monitor repayment activities, as credit reports list the details of the guaranteed loans as well,” said Mishra.
It is crucial to be careful in times such as these when many people are losing their jobs or seeing their salaries reduce.