Due Diligence. Want to guarantee a loan? Think again

A friend or a relative is taking a loan and asks you to become his/her guarantor. You may want to agree to it instantly, shrugging it off as a perfectly harmless request.

On the other hand, you may give assent as you find it difficult to say no. But before you step in, you must know what you are getting into. For one, if the original loan is unsecured, it is like a sword hanging above your head. Two, even if it is secured, you cannot assume that the bank will not knock on your door if your friend defaults.

This is because there are no hard and fast rules on whether the bank will liquidate the security first or ask the guarantor to pay up in case of a default.

Thirdly, this may also have an impact on your credit score, dampening your chances in case you apply for a loan in future.

While nothing has been laid down as to the kinds of loans that require a guarantor, banks are more likely to ask for one if the security pledged is not enough and/or the risk involved with the loan is more than normal. This is among the first things that should put you on your guard before you agree to become a guarantor.

It is important to understand that you are not only attesting the authenticity of the borrower, but are also financially backing the borrower in case of default, explains Adhil Shetty, CEO of Bankbazaar.com.

So, if the borrower defaults, the bank has every right to come after you to recover the money. What’s worse, if you too fail to pay, you will be tagged a defaulter. You may then not be able to obtain a loan for yourself in case you need one, or even a credit card.

The risk is all the more if you are guaranteeing an unsecured loan, in which case the burden of repayment falls instantly upon you following a default by the borrower. In case of a secured loan where the lender has some collateral to bank on, the guarantor may not be required to pay up if the asset pledged as collateral can be sold off to recover money after the borrower fails to repay. But all said and done, it is the bank which will take a call on how to recover the loan amount. For instance, if the collateral pledged is fairly liquid, such as national savings certificates, term deposits or Life Insurance Corporation of India policies, the bank can choose to liquidate these first.

On the other hand, if the collateral is relatively illiquid, such as a piece of land or a flat, the bank could straightaway approach the guarantor before it tries selling off the collateral.

A loan guarantor’s liability is said to be co-terminus with that of the borrower and a bank can take all the action against a guarantor (if he fails to pay up) that it would take against the original loan defaulter.

Even if one were to leave aside the possibility of default, becoming a loan guarantor in itself could have some consequences. For instance, by agreeing to stand guarantor to someone’s loan, you could adversely affect your own chances of getting a loan.

“Your credit report mentions you being a guarantor for somebody. How this information is taken by a bank is entirely upon the bank that is going to give you a loan. In most cases, it will impact your chances if the loan amount is higher with respect to your income,” adds Adhil Shetty.

The nature of the loan guaranteed — risky or safe — too affects your chances of getting a loan for yourself. So, unless you’re dead sure that you never intend taking a loan yourself, keeping away from guaranteeing a loan should stand you in good stead.

So, if you do feel queasy, you can get out of the equation. But backing out as a guarantor at a later date cannot be done without the bank’s consent. In that case, another guarantor or additional collateral may be necessary. However, finding someone else who can take over from you as the guarantor can pose some difficulty.

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