Let us assume you have a best friend who is looking to avail a home loan. He asks you to sign up as guarantor. Since this is a close friend of yours, you willingly sign the dotted line. But wait a second. Have you considered the possible impact of this? Do you know that your generosity can adversely affect your credit score?

Here is what you should know before you sign as a guarantor for a loan.

Which Types of Loans Need a Guarantor?

India’s banking sector is quite standardised, but there is one aspect for which there is no standardised RBI guideline. That is the nomination of a guarantor for a loan. Different types of loans ask for guarantors. These include home loans, education loans, and personal loans. In India, it is up to the individual banks to decide which loans need a guarantor and which do not.

Banks or non-banking financial company (NBFC) can ask for a guarantor when the loan amount is Rs. 5 lakh or above. They could ask for a guarantor even for a lower loan amount. That is usually if the borrower’s credit history or repayment capacity is less than desirable.

The need for a guarantor arises in the following circumstances: First, the loan applicant has a transferable job. Second, the applicant may have a job involving frequent travel out of the country. Third, he or she does not live in the city of his or her permanent address. Fourth, the loan applicant holds a high-risk job. Fifth, he or she is at an advanced age.

When Will a Bank or NBFC Contact You as a Guarantor?

The bank or NBFC will contact you only after sending the borrower a notice. It will send the notice to the borrower after he or she misses an EMI payment. If the borrower defaults on three EMI payments, the lender will send a registered notice. Suppose the borrower misses more than four EMI payments. The lender may then start legal proceedings against the borrower and the guarantor.

Are You a Financial or Non-Financial Guarantor?

A non-financial guarantor is simply a contact person. The lender contacts this guarantor when the borrower has missed EMI payments and is unreachable. A non-financial guarantor is not responsible for repaying the loan for the borrower.

A financial guarantor’s responsibility is to repay the outstanding loan. This guarantor would have to pay any late fees and interest charges as well.

How Does Standing as a Guarantor Impact on CIBIL Score?

As a guarantor, what is your responsibility? It is not limited to ensuring that the borrower pays his or her EMIs on time. You are legally bound to pay the loan if the borrower defaults on paying the loan. For the bank or NBFC, the extent of your liability is equal to that of the borrower. Suppose you sign as the guarantor for a loan. Credit-scoring agencies like CIBIL get this information. So, any defaults and late payments by the borrower will have a negative impact on your CIBIL score.

You may manage your own financial dealings with integrity and responsibility. For instance, you may pay your credit cards on time. Yet, standing as guarantor for a person who defaults on payments is a problem. It reflects negatively on your credit score. This impact makes it difficult for you to get a loan for yourself. It does not mean that you will not get a loan at all. But getting loan approval could be difficult. Any prospective lender would be cautious when assessing your repayment capability.

What Can You Do?

You should only stand as guarantor for a person you know well. Even then, it is wise to check their capability to repay the loan. You would not want to bear the burden of repayment if the borrower defaults on it, right?

If you have to stand guarantor for a loan, agree to do so for short-term loans. Avoid this for long-term loans. This is because your liability as a guarantor lasts as long as the tenure of the loan. Say, you a guarantor paying the outstanding EMIs. You cannot ask the lender to adjust the interest rate or tenure. But you can ask the borrower to add another guarantor when it grants the loan. So, if there is a default, two people can share the EMIs.

Summing Up

Many types of loans need guarantors. So, check the loan type, loan tenure, and the repayment capacity of the borrower. Beware that any default will have an impact on the CIBIL score of both borrower and guarantor. Check with the bank or NBFC to become aware of your responsibilities as the guarantor for a loan.

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