From bank's perspective the guarantor is treated as good as the borrower. In case the borrower does not pay, guarantor has to pay off the loan, failing which his credit score goes for a toss
Indranil is a project manager in an MNC earning about Rs 30 lakhs per annum. He is quite successful in his professional life and married with 2 kids. With a decent bank balance, own house (on loan), a mid-size car and kids studying at good schools, he has “arrived in life”.
His cousin’s son, Srikant, needs Rs 15 lakhs to finance his MBA education. He goes to Indranil to get one of the documents signed as guarantor. Indranil, the ever-loving uncle, signs the papers and hands it over. Things go well, until one day four years later, he receives a call from Srikant’s bank with a demand to pay up the loan since he is the one who guaranteed the loan. Indranil is in a fix. He has no idea what this means and why he should pay. The bank is persistent and Indranilis now contemplating taking the help of a lawyer.
This is a scary situation to be in. Having to pay for being a good Samaritan is not a position that is enviable.
Types of loan where guarantors are needed
Although almost every stream of banking activity has been regulated and standardized in India, nomination of guarantors is one area where banks do not have uniform guidelines. Individual banks have the right to decide upon the requirement of guarantor. Usually banks require one or two guarantors for higher amounts of loan. The amount for which guarantor is required can be from Rs 5 lakhs and upward. It also depends on the credit history and paying capacity of borrowers.Loans requiring guarantors include education loans, house loans, or any other loan where the amount borrowed is high.
The case of default by the borrower
Most of us forget that a guarantor is not only a witness or “someone” who attests the authenticity of the borrower but also guarantees that the person will pay up the loan. A guarantor in effect says that he is backing the borrower financially and guarantees that the loan will be paid back in case the borrower defaults on his payment. Naturally, the guarantor is liable in such a case.
Banks usually wait for a few months before they issue notice to the guarantor about the default by the borrower. From bank’s perspective, the guarantor is treated as good as the borrower. Hence, it is the responsibility of the guarantor to clear the loan. In case he or she doesn’t, the bank treats the guarantor as wilful defaulter. In the above case, if Indranil doesn’t pay up, he will be named wilful defaulter unless his lawyer and bank come up with a solution.
Impact on CIBIL score
Since banks assume no difference between guarantor and borrower in case of default, this impacts the guarantor’s CIBIL score as well as his credit score as reported by other agencies. Remember that when you guarantee a loan, this information is sent to CIBIL and other credit reporting agencies. While this doesn’t harm you at the outset, the issue arises when the borrower defaults.
This means it has negative impact on your CIBIL score if you and the original borrower defaults. Most guarantors do not realise this, though. Naturally, a low CIBIL score will hamper your ability to raise loan in future.
What to know before becoming a guarantor
Today, there is no credit information that is hidden from banks. Almost all banks can access your credit data from CIBIL irrespective of whether you have a relationship with the bank or not. With such increased transparency and availability of information, it is advisable not to become a guarantor unless you know the person well enough. You should assess the capability of the borrower to pay up. For example,if you are ready to become guarantor for education loan, check which college the borrower has selected for admission. It is easier for an IIM or IIT graduate to pay up the loan than someone from a lower ranked school.
Additionally, you should look at the liability of a guarantor in case of default by original borrower. You can get details on this from the bank concerned. However, if there is no information available in the documents or through the lending bank, rest assured that a guarantor is liable to pay up in case of default.
Finally, check the documents needed from you to become a guarantor. Provide only what is required and do not give too much information. For example, if you are becoming a guarantor for a loan of Rs 20 lakhs, don’t show an FD of 1 crore as proof. This may not harm you in anyway, but it is unnecessary to reveal this financial information.
Turning a guarantor may impact your capability to raise loan for yourself. For example, if you have loan of about Rs 30 lakhs for yourself and have become guarantor for another Rs 20 lakhs for someone else, this may have bearing on the amount of loan you can borrow further in future.
However, this is again an area where banks have discretionary power. They can frame their own rules on whether they should consider this fact while approving the loan. It would be advisable to speak with the bank concerned before becoming a guarantor for someone if you have plans for taking a loan yourself.