Don’t agree to guarantee another person’s debt or put up security for someone else,” says the Bible. Today, in a different age and era, when most can’t do without taking debt in some form or another, the age-old advice still holds true.
It’s difficult to say no when a relative or a friend asks you to guarantee her home loan. But a mere signature and a bit of paperwork could cost you dear at a later date. “A guarantor on a loan is someone who accedes to be accountable (legally liable) for the repayment of the borrower’s debt in case of default for whatever reasons,” says Uday Wavikar, a Mumbai high court advocate.
Also See When Banks May Ask For A Guarantor (Graphic)
So, even at the cost of sounding rude, consider what we have to tell you before agreeing to become a guarantor on a home loan.
Who can be a guarantor?
“Lenders prefer blood relatives, but friends and colleagues can also provide a guarantee,” says Kartik Varma, co-founder, iTrust Financial Advisors Pvt. Ltd.
Family, friend or colleague, becoming a guarantor entails a huge responsibility. So, banks will ensure you are able to bear that responsibility. Banks would check your credentials thoroughly on the basis of pre-determined criteria, such as income. Banks would also ask for details of your assets and liabilities along with copies of supporting documents. You would also have to sign a legal agreement.
Future loan prospects: Becoming a loan guarantor would significantly reduce your loan-taking capability. “If someone is a guarantor on a loan, his own loan eligibility comes down than what it would have been if he wasn’t a guarantor,” says Kamlesh Rao, executive vice-president (mortgages), Kotak Mahindra Bank Ltd.
When deciding a guarantor’s loan eligibility, banks would take into account the amount he has guaranteed and reduce his eligibility by that extent. Suppose you guarantee a home loan with an equated monthly instalment of Rs10,000 and you earn Rs60,000 per month and your monthly expenses are Rs45,000, your loan eligibility would come to Rs5 lakh. If you hadn’t guaranteed the loan, your eligibility would have shot up to Rs15 lakh.
Credit report will show liability: The borrower’s as well as your credit reports will mention that you are a guarantor. Says Arun Thukral, managing director, Credit Information Bureau (India) Ltd: “A guarantor’s report will state so. In fact, for any valid application, the bank can access the guarantor’s credit report.” Also, if the borrower defaults on the loan, it will reflect on the guarantor’s credit report.
What if borrower defaults
The reasons for default could be beyond anybody’s control: unforeseen financial hardships, unemployment, disability or even death.
Every bank has an internal recovery policy they adhere to. First, the banks would try and recover the debt from the borrower. But, if that doesn’t work, you will get a notice next. If the bank decides to recover the funds from you, you will be liable to make the payments.
Abhijit Bose, senior vice-president and head-retail assets, Development Credit Bank Ltd, says, “When the bank legally recalls the loan, the entire loan amount becomes payable.”
As a guarantor you can take a stand and ask the bank to sell the property and recover the dues. But remember that foreclosure is a difficult task and banks would prefer to collect the dues from you rather than sell the property since possession of property would increase the cost of recovery. Says C.S. Jain, head -personal banking group, IDBI Bank Ltd: “Law allows lenders to choose the legal means to recover money faster. Under the mortgagee’s right to redemption, the borrower will be asked to repay first, but if that’s not possible, banks can approach the guarantor instead of repossession of property.”
If you agree to pay: You may need a loan to repay the amount. If you already have your own loans running, getting a new loan would be difficult. “As a guarantor, if you repay the borrower’s loan by taking a home loan, you will not get any tax deduction nor will the borrower,” says Gautam Nayak, a Mumbai-based chartered accountant.
If you refuse to pay: Banks are a business entity and don’t like non-performing assets. Hence, they will go to every legal extent to recover the funds. Says Wavikar: “If you are a guarantor, you are liable to pay the debt if the borrower defaults. If you do not pay, under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, banks can attach your property, auction it and recover the money. Banks may make a recovery decree to attach your moveable and immoveable assets. Worse, you could go to jail.”
But banks can’t touch your employees’ provident fund and agricultural land.
Already a guarantor andwant to discard the role?
Can’t do it: You will have to bear the responsibility till the loan is fully paid off. Says Rao: “It’s not possible for the guarantor to back off from his responsibility since the loan was given based on his guarantee. It’s not even possible to substitute a guarantor.”
Exceptions to the rule: A senior officer of Union Bank of India, who did not want to named as he is not authorized to speak to the media, says, “In a few cases, banks may agree for change of guarantor, but it all depends on banks’ internal policy and the reason for change. Moreover, the alternate guarantor must be acceptable to the bank. Once the guarantor is replaced, the original guarantor’s liability is frozen for the amount (till the date he was the guarantor) he guaranteed.”
Also, you can’t stop being a guarantor on your own. Varma says, “The borrower can request the lender to change the guarantor, but the latter cannot do it on his own.” That means you will have to convince the borrower to change the guarantor; the borrower would then arrange for another guarantor and then approach the bank. If you are lucky enough to reach this stage, remember to take the required release letter, stating that you are no longer a guarantor on the loan. Also, get your status updated in your credit report. But you will get your documents back only after the loan is fully paid.
Be a guarantor only if...
You are sure of the borrower’s financial status and repayment capacity. Also, it’s important to know the reasons why the bank needs a guarantor (see graph). If it’s due to poor financial status or low creditworthiness, there’s no point.
Wavikar says, “It’s dangerous to remain guarantor to someone unless you are involved in any business where he takes security for you.”
If the borrower has a life insurance or a home loan insurance, wherein the insurance company agrees to take care of the debt in case of death or disability, you may consider being a guarantor.
Suresh Sadagopan, certified financial planner, Ladder7 Financial Advisory, says, “A person can take on a guarantor’s liability to the extent he can service with 40% of his income.
Illustration by Jayachandran; Graphic by Yogesh Kumar/Mint