scorecardresearchKnow 5 key underlying risks of being a loan guarantor

Know 5 key underlying risks of being a loan guarantor

Updated: 27 Apr 2022, 07:55 AM IST
TL;DR.

It is good to be helpful but not at the cost of your credit score. Check for various factors before accepting to assume someone else’s risk by signing up as the loan guarantor. You may not only lose money while repaying the loan but also damage your eligibility to seek a loan in the long run. 

Taking a loan

Taking a loan

How many times have we found ourselves on a sticky wicket when our relatives insisted we be guarantors of the loans they are seeking? This is because lending companies insist on a guarantor if the primary borrower does not enjoy a high credit score or has a risky job profile. While lenders are more than willing to dole out loans and money on credit, they are constantly on the watch for an inherent risk factor that they all wish to mitigate. Hence, their policies for asking their clients to get a guarantor who can assume the responsibility of the loan in the event of an anomaly.

Different lenders frame different rules for loan guarantors who earn sufficiently and are financially well enough to repay the loan amount sought. Irrespective of the reason behind you taking responsibility to repay the loan in case the borrower dies or is unable to repay the amount, you must be utterly cautious regarding the loan amount and the terms and conditions of the loan, especially, if it is a home loan or an unsecured personal loan. This is because the lender first liquidates the primary borrower’s assets in case of default by the primary borrower or the inability to repay by the co-borrower. However, if the lender finds it difficult to recover the outstanding loan amount along with the interest, it will send a notice to the guarantor to pay the remaining amount.

There are risks involved in being the guarantor of a loan. It is like assuming an unwanted liability that will only eat away at your earnings in the long run. This means instead of being altruistic, you must be astute while assenting to repay someone else’s loan. Be sure to check the credentials of the borrower, his or her employment status, income level, regularity of ITR filing, health conditions, etc. However, accepting to become a guarantor does not mean that you do not take necessary precautions. For example, you can ask the borrower to seek a loan protection insurance cover like a home loan insurance cover or any other to care of the liabilities in case of the sudden death of the borrower. Other than these, you must take care of the following factors before deciding to sign up as a loan guarantor.

Check the borrower’s ability to repay the loan

Know that the lender is seeking a guarantor for the loan as the borrower may be at a high risk of loan default. Irrespective of the camaraderie you may enjoy with the borrower, you must inquire about his income sources and seek details of his existing liabilities. Find out also the ratio of current assets that the borrower has to check for their liquidity as and when required. Ask the borrower to show his or her credit report or ask the bank for the credit score to learn about his or her credibility. Refuse to guarantee the loan amount if the credit score is less than 650. This is because if the borrower or the co-borrower default on the loan amount, you may have to end up bearing the liability of repaying the amount that is due.

Refrain if you need a loan yourself

Your eligibility to seek any loan, be it a housing, personal or vehicle loan, will decrease if the lender realizes that you are already signed up as a guarantor for another person’s loan. Lenders offer competitive loan rates to people with high credit scores. This can affect you adversely as credit rating institutions will rate you lower if you accept to be the loan guarantor. This also means that you will not be able to avail of loans at lower interest rates.

Secure loan protection insurance cover

If the borrower fails to repay the loan amount, the lender will send a notice to the guarantor to pay the dues. If you fail to fulfil the obligations as the loan guarantor, you will be declared a wilful defaulter and barred from seeking any loan in both the near and distant future. This is why you must ask the borrower to seek a loan protection insurance plan that can be used to repay the outstanding loan amount. This way, you will be relieved of the liability to repay the loan in case the borrower is unable to pay owing to financial contingencies or sudden demise.

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Sign an indemnity agreement

A clause introduced beforehand can save you much embarrassment and bitterness later. What if the guarantor defaults for any unknown or unforeseen reason? Thoughts like these can be put to reason with you asking the borrower to sign an indemnity agreement that binds him or her to repay you the amount that you had spent in relieving him or her of the loan liability. This is because withdrawing your name as the loan guarantor may be difficult once the loan amount has been sought. This explains why you must get an agreement made and signed beforehand.

Don’t ignore the red flags

You may want to continue your relationship or association with your relatives and friends intact, but believe me that money can be the biggest divider of all. If you really want to get rid of someone, offer to lend him some money and then ask for it back. Money has a revealing effect, and that is why you must not ignore the warning signals that come your way.

  • Refuse to be the guarantor if the credit report of the borrower looks weak.
  • If you intend to take a loan in the near future, it would serve best to refuse to be the guarantor of the loan.
  • If the borrower refuses to take a loan insurance protection cover, it is a serious warning that the borrower is not serious about repaying the liability or considers his or her debt lightly. In the absence of insurance cover, banks would compel you to repay the loan which can be taxing on your finances in the long run.

First Published: 27 Apr 2022, 07:55 AM IST