As a loan guarantor, you can help a friend or family member to avail credit when he does not meet the loan eligibility criteria set by the lender. But you must remember that the borrower and the guarantor are legally liable for repayment of the loan. A lender requires the borrower to bring a third-party guarantor on board when the credit involves additional risk or borrower does not meet loan eligibility criteria.
In case the original borrower does not honour his obligation or repay loan EMIs on time, the lender will compel the guarantor to repay the loan. Once you sign the loan agreement as a guarantor, you become liable to repay the loan in case the borrower defaults. There are always chances that you have to avail credit to repay the loan. Also, the loan guarantee will also appear in the account sections of your credit report. Hence, you must keep in mind the risks of being a loan guarantor before agreeing to become to loan guarantor.
Understanding Major Risks of Being a Loan Guarantor
Undertake Financial Responsibility of the Borrower
A lender requires the borrower to bring a third-party guarantor on board a loan only if he does not meet all loan eligibility criteria. For instance, a bank or financial institution may ask the borrower to bring a third-party guarantor on board if he does not meet the income requirements for a specific loan. Likewise, lenders also require borrowers with poor repayment track records to guarantee unsecured loans. The lender normally shifts the additional risk associated with a loan from the original borrower to the guarantor. When you decide to guarantee a loan, you agree to compensate the lender for the additional risk associated with the loan.
Loan Guarantee can be Limited or Unlimited
The quantum of guarantee differs according to the nature and type of the loan. According to the terms of the loan agreement, a loan guarantee can be either limited or unlimited. When the loan guarantee is limited, you are liable to repay a specific percentage of the original debt. On the other hand, you will be required to repay the loan fully if the guarantee is unlimited. Hence, you must determine the type of guarantee by reading the loan document fully. Your financial obligation will increase significantly if the guarantee is unlimited and the original borrower defaults payment.
Not easy to Mitigate the Financial Responsibility
Legally, the borrower and the guarantor are equally responsible for loan repayment. Once you guarantee a loan, you undertake the financial responsibility of loan repayment in case the original borrower defaults. But you cannot withdraw from the responsibility easily. The lender will approach you to repay the loan if the borrower defaults. You need to consent of both lender and primary borrower to withdraw from the responsibility. Also, no lender allows the original guarantor to withdraw from the financial responsibility without an alternative guarantee.
Affect Your Future Credit Prospects
When you guarantee a loan, the information will appear in the account section of your personal credit report. When you apply for a loan, the lender can easily know if you are a loan guarantor. He will further consider the amount of loan guarantee as a key criterion while evaluating your loan eligibility and creditworthiness. Hence, the loan guarantee will reduce your loan eligibility and affect your future loan prospects in the long run. Hence, you must not guarantee loans to keep your future loan prospects intact.
Impact on Your Personal Credit Score
As noted before, your personal credit report will depict that you are a loan guarantor. You are still responsible to repay the loan even if the primary borrower is repaying loan EMIs on time. In case the primary borrower defaults, your credit report will depict the information clearly. The lender will review your credit report thoroughly when you apply for a new loan or credit card. Hence, the loan guarantee will make it difficult for you to avail credit in future in case the primary borrower defaults. There are also chances that you have to avail credit at higher interest rate due to the information mentioned in your credit report.
As a loan guarantor, you become legally liable to repay the loan in case the borrower does not pay EMIs or honour his financial obligation. But your liability will differ according to the type of loan guarantee. Hence, you must read the loan agreement fully and understand the nature of loan guarantee clearly before signing the loan document. At the same time, it is important to keep in mind these risks of being a loan guarantor before agreeing to guarantee a loan.