Being a loan guarantor to a friend or family member is often considered a harmless financial arrangement. However, it does come with responsibilities and liabilities, especially if the borrower defaults on the loan.
We understand that refusing a friend or family members is often hard. Thus, before agreeing to become a loan guarantor to someone, consider what it entails and thoroughly examine the liabilities.
The role of a guarantor
If a person applying for a loan has a weak credit history and the bank is not convinced about their repayment capabilities, then the bank insists on a guarantor for the loan.
If the borrower defaults on the loan, the responsibility of paying the EMIs will fall upon the loan guarantor. Even if the borrower dies in the middle of the tenure and does not have home loan insurance, the bank will reach out to the guarantor.
The downsides
Impact on your credit score: You read it right! In case the borrower defaults on the loan, it will impact your credit score too.
Also Read: Ways to Boost Your Credit Score
Impact on your loan eligibility: As mentioned above, being a loan guarantor comes with responsibilities. Once you become a guarantor, your loan amount eligibility will reduce. This is because the bank will assess your liabilities, which includes any loans that you have guaranteed.
Let’s assume that you (a guarantor) want to apply for a home loan of Rs 70 Lakh. And you are a guarantor to your friend whose loan amount is Rs 40 Lakh. In most cases, the bank will only sanction you about Rs 30 Lakh as you have already guaranteed another loan for Rs 40 Lakh. If you apply for the same amount, your application could even be rejected by the bank.
However, the terms and conditions for being a guarantor vary from bank to bank. Thus, it is good to read the documents carefully.
Difficulty in getting NOC: Another common downside is the difficulty in obtaining the no-objection certificate from the bank. This is only if you already have a home loan and you have also guaranteed someone’s else loan.
Here, let’s say that you want to close your loan, but the other borrower (for whom you are a guarantor) is defaulting on payment, then you won’t get the NOC from the bank despite being diligent on your payments. Please understand that this is a crucial document that you must get from the lender after you close your loan as it states that you have paid back the loan and there are no further dues payable from your end.
Also Read: Tasks to Complete Before Closing Your Home Loan
Can you opt-out?
Now, you must be thinking of opting out of this financial arrangement. Unfortunately, it is not an easy task as it involves getting approval from the bank and the borrower. Bank, in most cases, will only agree if the borrower finds a new guarantor. Once you agree to become a loan guarantor, there is usually no turning back till the loan tenure ends.
What should you do?
Well, two words – tread carefully.
- If somebody approaches you for being their loan guarantor, try to understand their financial standing and repayment capabilities. Also, try to understand why is the bank insisting on having a guarantor – is it because their credit score is low or because of any other reason.
- If you plan to buy a home in the near future, it is not ideal for you to be a guarantor for somebody else’s loan as it will impact your eligibility.
- Lastly, if you agree to become one, make sure you are financially strong and have enough funds to repay the loan if the responsibility falls upon you.