The risks of being a loan guarantor

If one of your relatives, friends or office colleagues asks you whether you could become a ‘guarantor’ for a home loan he is applying, you may obliged to reply in the affirmative. By consenting to become a guarantor, you have exposed yourself to a contingent liability, wherein if the borrower defaults in the repayment of the loan amount, you become fully liable for repayment of the outstanding loan amount. This is because when the borrower defaults in repayment of loan instalments, his balance loan amount is considered as your loan amount and, as a guarantor, you are legally obliged to repay the outstanding loan amount. If you fail to repay the loan amount, the bank may take legal action against you and the borrower and initiate recovery proceedings against both. Such action by the bank can also lead to reduction in your credit score.

Hence, it is necessary to exercise caution while becoming a guarantor. You need to find out the terms and conditions of the loan and also the repayment capacity of the borrower. Also, if it is a big ticket loan such as home loan or a car loan, you should not volunteer to become a guarantor as any default on the part of the borrower can transfer the repayment liability on you (if you are the sole guarantor), which can create a serious stress on your finances. It would be better if there are three guarantors (including yourself) so that you do not carry the entire burden of loan repayment on you alone, but share it with one or two other guarantors.

Nevertheless, as a guarantor, if you decide to take on the responsibility of repaying the outstanding loan amount of your friend, relative or colleague, you need to be sure that the repayment does not cause liquidity crunch or financial stress for you. You have to be aware of your liability in case the borrower defaults and make sure that your income is adequate enough to meet the liability as well as meet your own financial responsibilities towards your family.