Nowadays, access to your house or car or that dream holiday has
been made easier by lending companies offering credit and loans at increasingly competitive rates.
However, one must note that taking a loan doesn’t solely depend on the
borrower’s financial standing. If lenders feel that the financial health of the
end borrower cannot be determined standalone, or in case the borrower has no source
of income, another option to get a loan processed includes involving a
guarantor. Apart from facilitating an individual to fund his education or
business, such an arrangement propels financial inclusion, thereby enabling the
economy to grow holistically.
Naturally, for a financial institution, it is of paramount
importance to make sure that the borrower has the capacity to repay the loan
with due interest. In case the primary borrower defaults, a guarantor’s role is
extremely crucial, as they become the fall-back option for the lender. Lenders
insist on guarantors for loans in which there is no appropriate collateral,
such as education and unsecured installment loans. For other loans too, lenders
can insist on one, especially if the lender has a reservation on the repayment
ability of the primary borrower. Data shows that loans backed by guarantors
have lower default rates than the average of the portfolio in products like
commercial vehicles. Hence, the creditworthiness of the guarantor is of substantial
importance.
In India, several loan accounts, specifically education loans,
are backed by guarantors. In the case of education loans, over 80 percent of
the loans are booked with guarantors since the primary borrower would not be
earning for the duration of his/her education. In most cases, a loan gets
approved at the behest of a guarantor, who indirectly assumes the
responsibility of furnishing the loan though he is not the end borrower.
Guarantors are legally responsible to assume the liability if the primary
borrower defaults. A guarantor’s role doesn’t end with the disbursal of the
loan; this is where the responsibility actuality just begins. There are several
issues that guarantors need to know, who choose to be good Samaritans for their
friends’ or family members’ cause.
Most importantly, a loan sanctioned will directly impact the
guarantor’s credit report and score. Though a guarantor might
be financially prudent and disciplined in paying his or her own equated monthly
installments (EMIs), credit card bills, the friend or relative who they are
backing might not emulate that same responsibility. Should the friend or family
member miss a payment or make a late payment, the guarantor’s credit history
and score would be negatively impacted. Therefore, one should keep in mind that
the moment they sign as a guarantor for a loan, it shows up in their credit
report with a clear indication that they are the guarantor. The guaranteed loan
will reflect on the guarantor’s credit report and will be used by the lending
institution when eligibility for a loan is calculated.
Additionally, it is advised that the following facts are taken
into consideration before signing up as a loan guarantor. One must also
remember that a guarantor cannot take a stance on deciding the limit of
liability towards the loan. The very purpose of getting a guarantor for a loan
is to make sure that the bank has an alternate source of recovery if the
principal debtor defaults. So, one must not always go by the credit repaying
capability of the end borrower alone. Instead, a guarantor must calculate his
own financial capability before signing up.
At the same time a guarantor needs to bear in mind his own
financial goals. If the prospects of purchasing a new home or starting up a
business are on the horizon, the guarantor should stick to backing small loans
that will not weigh heavy on a credit report. A financial institution might
refuse credit or might reduce the amount of credit to the guarantor if he or
she is already backing another loan of a fairly large amount. If at all one has
to become a guarantor, getting another guarantor to go in on the loan, as the
liability could then be split between the two guarantors. The strength of the
relationship with the primary borrower based on which one becomes a guarantor
needs to be borne in mind as especially in long term loans.
There have been cases where a guarantor has been penalized for
the principal applicant’s delinquency. Hence, it is not wrong to assume that a
guarantor’s liability could be more than the principal borrower’s. Even if the
guarantor has a good track record of repayments or good credit history, a
delinquency could act as a deciding factor for creditworthiness when banks
access credit reports. So before signing on the dotted line, a guarantor should
weigh all of the pros and cons associated with the financial backing of friends
and family.
Source: Secondary
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