Watch out for the consequences. In the event of default by the borrower, the eligibility of the loan guarantor is reduced to the amount of the loan. This is apart from taking responsibility for the loan
Proverbs 22:26 of the Bible says, “Do not promise to be responsible for someone else’s debts.” And that age-old financial advice is still relevant even today.
On August 15, India’s Supreme Court ruled that banks must take action against guarantors even though insolvency code proceedings were pending. It was about business loans. But what if it’s a family member or close friend who asks you to become their loan guarantor? Often times, it’s just hard to say no.
Rajan Pental, Group Chairman and Group Head – Branch and Retail Bank at Yes Bank said: “Any loan that needs to be secured by more than just cash flow from the primary borrower, may require collateral such as a loan on real estate or working capital facilities for small and medium-sized businesses.
In fact, many public sector banks require loan guarantors on student loans in excess of certain amounts. Sachin Chaudhary, COO, Indiabulls Housing Finance, said: “Real estate finance companies generally only require a guarantor against an applicant in certain cases, such as no co-applicant, high-risk applicant profiles or solidity. lower financial. “
This means that if your family or friend asks you to guarantee a loan from a housing finance company, you should probably check the borrower’s repayment capacity before agreeing. Chaudhary added: “It is advisable to become a guarantor only when one is absolutely sure of the credibility of the applicant and his ability to repay the amount borrowed”.
Impact on credit rating
If you think being a guarantor is just signing a dotted line for a family or friend, think again. Pental said: “One should be aware that the guarantor shares equal responsibility for the repayment of the loan and that in the event of default by the principal borrower, it is the responsibility of the guarantor to pay all contributions to the lender. . “
In short, your financial life is at risk, as is your credit rating. Sujata Ahlawat, Head of Direct-to-Consumer Interactivity, TransUnion CIBIL, said: “Banks and financial institutions require a guarantor for certain loans, as a guarantee for the amount of the loan they give. The guarantor guarantees the lender that he will honor the obligation in the event of non-payment by the borrower. The missed payments will not only be reflected in the credit report of the guarantors, but will also have a negative impact on their credit score.
Don’t forget that of the borrower, as well as your own, that is, the credit reports of the guarantor will mention that you are the guarantor. Vaishali Kasture, Managing Director and Country Head, Experian India, said: “As a guarantor, you are legally responsible for the debt of the borrower. When lenders share information about loan performance, the contact details of the guarantors are also shared with those of the primary borrower. These are reflected automatically on the credit report along with the full credit history. In the event of non-repayment, the credit rating of the guarantor is also affected as well as that of the principal borrower. A low credit score will have an impact and cause obstacles when applying for a loan in the future for both parties.
This means in the event of default of the borrower; your credit score takes a hit and therefore hurts your future loan eligibility. But that’s not all, every time you agree to become a loan guarantor for someone, your loan eligibility is actually reduced. After all, when you are someone’s guarantor, the bank usually narrows your eligibility to the extent of the collateral you have defended, as that responsibility can be transferred to you if the original borrower defaults. Pental said: “To approve someone as a guarantor, banks usually assess the guarantor’s creditworthiness, reputation, equity, and the guarantor’s relationship with the borrower.”
Before becoming a guarantor
Banks also do due diligence regarding the guarantor. It is wise that you do your part.
First of all, remember that it is important to be well informed about your own financial profile, it is just as important to understand the credit profile of the person for whom you choose to be a guarantor. Kasture said: “As a guarantor you have an obligation under conditions where the principal applicant is unable to repay. This could leave a long-term impression on the creditworthiness of the guarantor, so it is imperative to understand the financial and credit behavior of the person.
Second, while taking collateral, it is not enough just to know the person. Asking questions to do a full due diligence on the borrower is just as important. Understand why they need a guarantor and how they plan to repay the loan.
Third, Ahlawat said, “Think carefully before agreeing to become a guarantor, and keep track of how many loans you guarantee. This can impact your credit rating, your access to credit, and possibly your financial goals. If you can’t say no when someone asks you to be their loan guarantor, remember that you could be in serious trouble even if a borrower defaults.
Fourth, even if you are a guarantor of a loan, regularly monitor your credit report and score to check the loan repayment status and identify if something is wrong.
Kasture said, “Have a clear understanding of the rationale behind the credit commitment. Research and read around his past credit behavior. Encourage major borrowers to also monitor their credit report and credit rating, and reduce over-indebtedness on their credit limits. This will help them track their credit risk and verify the correct loan repayment information in their reports.
If the borrower defaults, the banks would first try to collect the borrower’s debt. But, if that does not work, the guarantor will then receive a notice. As a guarantor, you can ask the bank to sell the borrower’s property and collect the contributions. Or you can pay the dues to save the property. But if you don’t have the funds, you might even have to take out a loan for the same amount.
Therefore, it makes sense to avoid such huge financial liability, even at the cost of appearing rude to a family member or friends.
Source: DNA of Money