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Signing as a loan guarantor? Here's how the liability affects your credit score

Whenever a default takes place, the lender can demand that the loan guarantor step in and repay

April 29, 2021 / 12:00 PM IST

Stepping in as a loan guarantor for those unable to avail a loan on their own is a serious financial commitment. Any default or delay in the repayment of the guaranteed loan can have a long-term impact on the financial health of the loan guarantor. Hence, it is important to take into consideration the following factors before stepping in as a loan guarantor.

The difference between a co-borrower and loan guarantor 

Both co-borrowers and loan guarantors are responsible for repaying loans on time with their primary borrowers. However, most of the banks only allow close relations to be a co-borrower. On the contrary, anyone beyond the specified list of relations can become a loan guarantor. In case of a guaranteed joint loan, the repayment liability for the guarantor would only arise after the primary borrower and co-borrower(s) fail to honour the repayment commitment.

When do lenders ask for a loan guarantor?

Lenders usually ask a prospective borrower to loop in a loan guarantor when they are either unsure or not satisfied with the loan eligibility and/or repayment capacity of the primary borrower and their co-borrower. Lenders can ask for a loan guarantor for any type of secured and unsecured loans, depending on their risk evaluation and risk management policies.

Circumstances when lenders may demand a loan guarantor include higher loan amount, risky job profile or employer profile of the loan applicant, inadequate credit score of the loan applicant, primary borrower nearing or already beyond the cut-off age for loan applicants, etc.

Also read | Joint home loan application: For higher amounts and increased tax benefits

Evaluating a loan guarantor

As in the case of primary borrower and loan co-applicant, lenders consider the income, credit score, repayment capacity, job and employer profile, etc. of the proposed guarantor while evaluating his eligibility as a guarantor of the proposed loan.

Liabilities of becoming a loan guarantor

Stepping in as a loan guarantor makes you liable for timely loan repayments if the primary borrower and co-borrower(s)  fail to do so. Whenever a default takes place, the lender can demand the loan guarantor to step in and repay not only the outstanding loan amount but also the applicable penal rates and charges incurred on unpaid dues.

Thus, those agreeing to step in as a loan guarantor should persuade the primary as well as co-applicants (if any), to go for a loan protection insurance plan. However, keep in mind that these insurance plans do not cover loan defaults. It  will only cover the contingency arising due to the demise or disability of the primary/co-borrower of the loan.

Also read: Stood as guarantor? Know how to protect yourself if the borrower defaults on loans

 Impact on the guarantor’s loan eligibility

Once an individual gets roped in as a loan guarantor, his loan eligibility gets reduced by the outstanding amount of the guaranteed loan. Lenders tend to consider the outstanding loan amount of guaranteed loans as contingent liabilities of the loan guarantor. Therefore, one should thoroughly assess probable financing requirement in the short and mid-term before committing himself to become a loan guarantor.

How it affects credit scores

Any form of default or delay in loan repayment by the primary borrower/co-borrower(s) can adversely impact the credit score of the loan guarantor as well. Thus, always evaluate the financial stability and discipline of the primary borrower and co-borrower(s), if applicable, before guaranteeing any loan.

Existing loan guarantors should make sure to closely track the repayment activities in the guaranteed loan account. Loan guarantors should also fetch their credit reports periodically, as any delay or default in the loan repayment will also reflect in their credit report.

Also read: How CIBIL and Experian score first-time loan applicants

Opting out from being a loan guarantor

After stepping in as a loan guarantor, one cannot withdraw from the existing responsibility until the lender and primary and co-borrower(s) are able to find a mutually acceptable new replacement for the original loan guarantor. This becomes another reason for loan guarantors to carefully assess their near and mid-term financial requirements before agreeing to commit loan guarantee.

Naveen Kukreja is CEO and Co-founder,
first published: Apr 29, 2021 12:00 pm