From credit score impact to financial burden, 5 loan risks every borrower and guarantor should know

When you apply for a personal loan, it is generally viewed as a personal finance decision. Still, when a new guarantor is introduced into the scheme of things, the responsibility naturally extends beyond the primary borrower.

This calls for a proper analysis and understanding of the concept of a ‘loan guarantor’ so that an aspiring borrower and their associated guarantor are better equipped to make sensible decisions before agreeing to rope in anyone else as a guarantor.

Many individuals become guarantors for their friends, family, and near and dear ones without fully acknowledging the long-term economic implications of such a move. Given that such a step can appear to be a nice gesture of affection and respect, serving as a guarantor for a loan can expose a person to serious financial and credit-related complications.

Mahesh Shukla, Founder & CEO, PayMe, explains this concept, “Many borrowers unknowingly transfer financial risk to their loved ones by making them loan guarantors. A guarantor's credit score, assets, and savings are equally at stake if repayment fails. As lending evolves, creditworthiness must be assessed on individual merit, not on the financial burden of another person. At PayMe, no guarantor or collateral is needed, because trust should never come at someone else's expense.”

Who is a loan guarantor?

To put it simply, a loan guarantor is a person who agrees to provide legal backing and take responsibility for repaying a loan if the borrower fails to meet their repayment obligations. Lenders generally require guarantors when an individual's borrowing profile is weak, has a limited or broken credit history, or lacks sufficient backing to secure the loan at reasonable interest rates individually.

5 risks of being a loan guarantor you should know

1. Credit score impact: Even if the primary borrower misses or defaults on payments, this can have a direct negative impact on the guarantor's credit profile and credit score.
2. Financial liability: In the event of a definitive default with no scope for repayment, the guarantor may be legally required to repay the outstanding loan amount. This can make the entire process stressful and complicated for a guarantor if they are unaware of the terms of the personal loan agreement.
3. Asset risk: The loan guarantor's personal savings or assets could be at risk in the event of loan default. This can be one of the most serious ramifications of being a loan guarantor. According to the terms of agreement, if stated, the money can also be recovered by selling the assets/ property of a guarantor if the primary loan account holder defaults and fails in meeting pending debt obligations.
4. Reduced borrowing capacity: Existing guarantee obligations may affect future loan approvals. This is because the credit score of a loan guarantor in such a case can take a serious beating. It is normal to witness serious declines, thus making future loans and credit cards more complicated to secure.
5. Relationship strain: Financial disputes can create tension between family members, near and dear ones and friends. A case of a loan default can easily go out of hand and turn into an emotionally driven legal battle.

In short, before agreeing to serve as a loan guarantor, individuals should carefully evaluate the pros and cons, as well as their personal financial and legal responsibilities. Understanding the risks and having a frank conversation right at the start can help prevent unexpected liabilities, pain, and trauma later on. It can also ensure that financial support does not come at the cost of personal financial security.