Know the risks of being a loan guarantor

When a relative or a close friend approaches you asking you to become a guarantor for his loan, you may sign on the dotted line without even looking at the terms and conditions in the loan document. That may be just as well if the borrower has an impeccable record of repaying loans in the past or if you are sure that he is financially well-off to be able to repay the loan. But what happens if the borrower defaults in repayment of the loan due to sudden loss of job or financial loss sustained by him in his business? Well, in such a case, you will be called upon by the bank to repay the outstanding amount of loan. The collateral damage of a default by the borrower is that, as a guarantor, your own credit rating might be downgraded and, consequently, your borrowing capacity would reduce to the extent of the outstanding loan amount.

Banks and finance companies may ask for a guarantor in the case of certain categories of borrowers. If the borrower is from a low income group or he is employed in a high risk profession (such as construction worker, mine worker, etc.) or if he is of an advanced age or has a low credit score and poor repayment history, he is deemed to belong to high risk category of borrowers as the risk of default is considered to be high and the bank would ask for one or more guarantors.

As a guarantor, you are legally liable to repay the outstanding loan amount if the borrower defaults on repayment. On default by the borrower, the bank will first seize and liquidate the assets of the borrower to recover the loan amount. If that does not suffice, the bank will call upon you to repay the balance loan amount. However, if you also fail to repay the loan amount, the bank has the right to seize and liquidate your assets to recover the outstanding loan amount. So, by being a guarantor, you are exposing yourself to financial risk.

Not only that, as a guarantor, your eligibility for loan reduces as the lender would factor in the loan amount of the borrower (to whom you are a guarantor) to determine whether or not you are eligible for a loan. Even if you are eligible, the amount of loan would be reduced to the extent of your primary borrower’s loan amount outstanding or you might be offered a loan on a higher rate of interest.

So, being a guarantor comes at a price and, therefore, you need to ponder over these aspects if you wish to sign up as one.