Guaranteeing a loan requires careful analysis before making the decision; you should not guarantee a loan just because a friend or acquaintance has asked you to do so, warns Rajiv Raj
Did you know that being responsible about your own debt is not a sure shot way of having a healthy CIBIL score in case you have guaranteed a loan? If you are wondering why then here is the answer: guaranteeing a loan means that you take on the responsibility of repaying the loan you guarantee in the event of a default.
Thus not only how you treat your own debt but how the person's whose loan you have guaranteed treats her/his loan, together decide the fate of your CIBIL Score.
Guaranteeing a loan requires careful analysis before making the decision; you should not guarantee a loan just because a friend or acquaintance has asked you to do so.
Some of the conditions in which a loan guarantee is required are: when the borrower has a poor CIBIL score; the value of the security is not sufficient; or in the case of student loans when the borrower has no income or assets in her/his name.
How does guaranteeing a loan affect the CIBIL Score?
Consider Ankita's example: she applied for a car loan and was surprised when her application was rejected due to a low credit score. She was surprised as she had always been very meticulous about her repayments. On going through her CIBIL Report she realised that she had guaranteed an education loan for a friend of hers; her friend as per the report had defaulted on the loan.
Ankita was crestfallen; being regular about her payments throughout had been marred by one oversight of not being careful about guaranteeing a loan.
Often people might think that when one guarantees a loan her/his responsibility ends there or they might simply forget that they have guaranteed a loan since loans run for long periods and the guarantor gets no intimation about a default or delayed payment by the principal borrower. The guarantor is not informed when the borrower defaults on a payment the first four times; after that a legal notice is sent to the both the borrower and guarantor thus giving the guarantor very little breathing space.
When you guarantee a loan it becomes linked to your CIBIL score; just like any default that may occur on a loan taken by you, any default on a loan for which you are a guarantor will reflect in your CIBIL Report. Each delayed and missed payment will be reflected both in the borrower's and guarantor's CIBIL Report.
If the loan (that you have guaranteed) is settled with partial payments, that also does not augur well for you CIBIL score.
Guaranteeing a loan also reduces your borrowing capacity. Just like your own loan you are responsible for the guaranteed loan; which limits your capacity to borrow further. If there is a default on the guaranteed loan, due to which your CIBIL score is impacted negatively you might find it difficult to get a fresh loan due to poor CIBIL score.
Should you guarantee a loan or not?
There is no clear yes or no answer to this one. This will be determined by your own financial situation, how well you know the person whose loan you are guaranteeing, her/his credit worthiness, type of loan etc.
In case of secured loans, the lender has the option of liquidating the asset to make the recovery so the guarantor's liability is limited. There may be a negative impact on your CIBIL score but you may not be asked to repay the loan. If you know the borrower well and are sure of her/his intentions and ability to repay then you could guarantee a loan.
Apart from that get a reality check about your own financial condition; are you in a position to pay in the event of a default? Do not consider guaranteeing a loan if you are planning to take a huge loan in the near future or do not know the borrower well.
Guaranteeing a loan could be life saver in some conditions. If a person applies for a loan and due to some reason (low income or a not so good CIBIL score) the loan is rejected, guarantee by the spouse/father/son could help the person secure a loan.
Any financial decision requires that you think about it and its long term impact. Guaranteeing a loan is not different; so understand the full implications and responsibility of being a guarantor before you choose to become one.
Photograph: Omar Bárcena/Creative Commons
The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.