Amit Saxena (name changed) is a software professional who was asked by his friend to be the guarantor for a loan of Rs 2 lakh (Rs 200,000). Being a very 'close friend' Amit agreed immediately.
Six months through the loan the friend disappeared without any trace and Amit was left with the substantial burden of paying off the loan.
This could be a situation where you could be caught up. Many of us at one point in time or other have been asked to be a guarantor for a friend's or relative's loan.
Our answer to the request may have been based on any reason. However, in a culture like ours where we are prone to help our friends and relatives, it is important to understand the pros and cons of being a loan guarantor.
Who is a guarantor?
A guarantor is someone who agrees to be responsible for the payment of someone else's debt should the latter default on payments. It is important to understand that being a guarantor is not a mere formality to help a borrower obtain a loan. The guarantor is equally responsible for paying off the loan.
When is it okay to be a guarantor for a loan?
Being a guarantor is always risky because you cannot guarantee another person's behaviour. However, since it is very subjective, the decision to be a guarantor should be based on the knowledge of the borrower's financial capability to pay off the loan.
When is it not okay to be a guarantor?
If you come to understand that the bank is asking for a guarantor because of it is unsure about the borrower's repayment capability, it is important to take a close look and understand the borrower's financial capability yourself.
Is being asked for a guarantor an indicator of the credit-worthiness of an applicant?
While credit-worthiness is one of the major reasons a person is asked for a guarantor, it also does not necessarily mean that the borrower's credit-worthiness is being questioned. It could be based on other reasons such as:
The applicant has a transferable job;
The applicant job's involves frequent travel abroad;
Loan is applied at a place other than the applicant's permanent address.
What can happen if the person whom I have agreed to be a guarantor for defaults?
When you sign on the dotted line and agree to become a guarantor, you are legally bound to pay off the debts if the primary borrower defaults. If the borrower does default, then:
Banks will hound you to clear the debts.
Personal assets such as bank accounts, cash as well as property could be attached (except for provident fund and agricultural land which cannot be attached under any court decree) and you could turn bankrupt.
Your credit standing could get affected; which means that if you need any credit in future, your chances of getting the same could be dim.
Will being a guarantor impact my chances of obtaining another loan?
Yes, it will. Most banks and financial institutions look at the loan that you are a guarantor for, as a loan that you hold. They will therefore deduct that much amount from your loan eligibility.
Also, if the borrower has defaulted on some payments during the course of the loan, this also shows up on the guarantor's credit history. This can additionally reduce your chances of getting a loan.
How should I decide whether to be a guarantor or not?
An important question to ask your self when you are asked to be a guarantor is 'Am I ready to repay the loan?' If the answer is yes, go ahead, be a guarantor. If no, then you have to base your decision on a stronger reason than 'He is a close friend.'
On a final note, if you do become a guarantor, you have to understand that there is no turning back. You cannot revoke your guarantee after the loan has being sanctioned. So, before you do sign the dotted line, check whether the contract tells you the amount you are guaranteeing, the situations in which you will have to repay the loan and if the amount to be borrowed can be increased without you being told.
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