NEW DELHI : A relative wants a home loan but the bank is asking for a guarantor. Or perhaps a friend needs you to sign some papers so that a loan can go through. If you trust the person, agreeing may not seem like a particularly big decision.
But guaranteeing a loan is much more than helping someone with paperwork. You are taking on a financial responsibility that could affect your own money and ability to borrow if things go wrong.
A loan that you guarantee can appear on your credit report even though you have not borrowed the money yourself. CIBIL says guaranteed loans are reflected in the guarantor’s credit report because the guarantor has agreed to meet the obligation if the main borrower cannot repay.
Becoming a guarantor does not automatically damage your credit score. The problem arises if the borrower starts missing repayments or defaults on the loan. CIBIL says a default by the principal borrower can affect the guarantor’s CIBIL Score as well.
This can become particularly important if you are planning to borrow yourself. You may be preparing to apply for a home loan or car loan a few years later, only to discover that problems with a loan you guaranteed have affected your credit profile.
The risk is not limited to your credit score either. You could also become responsible for the money owed.
According to section 128 of the Indian Contract Act, 1872, the liability of the guarantor is co-extensive with that of the main debtor, unless otherwise provided in the contract. In this case, the creditor may claim his payment from the guarantor, in case of default by the debtor.
In addition, it was ruled by the Supreme Court that it is not always necessary for a creditor to exhaust all his/her remedies against the borrower before approaching the guarantor.
This is why it would be better if you study the guarantee clause in detail and do not just sign wherever the lender requests you to do so.
Find out what your liabilities are under this clause. Are they only limited to a certain amount or they extend to the whole debt outstanding? If the loan amount is substantial or the terms are difficult to understand, consider getting independent legal advice before agreeing.
It is equally important to look at the borrower’s finances. Don’t base your decision only on the fact that the person is a close friend, sibling or relative. Find out whether they have a stable income, how much debt they already have and whether the proposed EMI looks affordable.
Also ask yourself a much less comfortable question: if this person could not repay the loan, could you?
If making those repayments would mean dipping into your retirement corpus, selling investments meant for your children’s education or taking another loan yourself, you may be accepting more risk than you can comfortably handle.
Don’t assume that you can simply remove your name as guarantor if you change your mind later. For an existing loan, your release will generally depend on the loan agreement and the lender agreeing to the change. The borrower may need to provide another acceptable guarantor, refinance the loan or repay it. If you are released, get confirmation from the lender in writing.
There is nothing wrong with helping someone financially when you understand and can afford the risk. But signing as a guarantor should be treated very differently from lending someone a small amount of money.
Before saying yes, think about the worst-case scenario rather than only the most likely one. You may never have to pay a rupee towards the loan, but you should sign only if you are financially prepared for the possibility that you might.
