If a family member or friend asks you to become a loan guarantor, it is difficult to refuse. However, before agreeing to become one, you must consider what it entails and whether you are comfortable with it.
Who is a guarantor?
Simply put, a guarantor on a loan is someone who agrees to be accountable (legally liable) for the repayment of the borrower’s debt in case of default for whatever reasons. So if your friend can’t or won’t pay, you will have to repay the borrowed amount.
What happens if the borrower defaults?
In case the borrower defaults on the loan, the lender would first approach the borrower to take care of the dues. However, if the borrower is unable to do so, the lender will then get in touch with you, the guarantor, to settle the dues. The lender is within its rights to recover funds from you. Keep in mind that when a bank legally recalls a loan, the entire loan amount becomes due.
You can ask the bank to sell the property and recover the dues. Or you can pay the dues to save the property. If you don’t have the required funds, you could also take a loan for the same. Under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, banks can attach your property, auction it and recover the money. But then that’s the worst-case scenario.
How can becoming a guarantor affect you?
Effect on your future loan prospects: When you agree to become a loan guarantor for someone, your loan eligibility gets reduced. If 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.
Effect on your credit history: Your credit report will mention that you are a guarantor for a loan. In fact, banks can also access your credit report as a guarantor for valid application. If for some reason the borrower defaults on the loan, this information will also reflect on your credit report.
What should you do?
Do not become a guarantor unless the loan is for your spouse or child. Avoiding such huge financial liability even at the cost of sounding rude to a family member or friends makes sense.
If you are already a guarantor for a friend or relative, but are not confident of his/her repaying capacity, you could ask the borrower to release you from being a guarantor. But that can happen only if he finds another guarantor. Unfortunately, you cannot approach the bank to cancel your guarantee, only the borrower can initiate this request. Also, some banks do not allow change of guarantor.