How Becoming a Guarantor for Loan Can Affect Your Credit Score

Being a loan guarantor has a direct impact on your credit score, especially if the borrower defaults on the loan. It not only places a heavy financial responsibility on your shoulders but also impacts your chances of loan approval. That’s why it’s important to understand the responsibility involved and the potential risks before entering into a guarantor agreement.

This blog explores the role of being a loan guarantor, alongside the impact it has on your credit score. Read on to know more.

What Does Being a Loan Guarantor Mean?

A loan guarantor is someone who legally agrees to take on the financial responsibility of repaying the loan if the primary borrower defaults. It's a binding agreement where the guarantor acts as a form of additional security for the lender. This is common when the borrower has a limited credit history, a poor credit score, or is requesting a high loan amount; lenders are more inclined to extend credit with a guarantor.

A guarantor agreement will be drafted, specifying the debt amount, the guarantor's liability, and the conditions under which they would have to make repayments. The liability can vary from 20% to 100% of the loan amount, depending on the specific terms of the agreement. If, for whatever reason, the guarantor refuses to pay the amount when required, the lenders have full authority to take legal action against them.

Unlike a co-borrower, who shares the loan from the start, a guarantor literally 'guarantees' that the loan will get paid, and only becomes liable when the borrower fails to repay the loan. That being said, the borrower's debt will still reflect in the guarantor's credit history even if they’re not making monthly payments.

Also Read: Top 8 Useful Tips to Get Your First Personal Loan

The Impact on Your Credit Score

Far from a simple favour to a family member or friend, being a loan guarantor significantly affects your credit score alongside other important aspects.

• Initial Credit Impact: Once you become a guarantor for a loan, the loan appears in your credit report as a liability. The outstanding debt becomes part of your profile and can influence your borrowing capacity.

• Impact of Missed Payments: If the primary borrower maintains a good credit history and repays consistently, your credit score remains unaffected. However, any delayed payments reflect on your score as well. Even a single late payment can hurt your score; a 30-day delay can reduce your score by as much as 50-100 points , as reported.

• Defaulting Consequences: If the borrower defaults, you become responsible for the full extent of the loan according to the terms. This includes the loan repayment, penalties, interest, and any other costs. In addition, your score takes a bigger hit that is tougher to reverse. The lender can pursue legal action, such as seizing your assets, to recover the loan amount should you be unable to repay the loan.

How Guarantorship Affects Your Borrowing Capacity

Having the tag of 'guarantor for loan' in your credit profile can be a hindrance when seeking financial assistance for yourself. Lenders assess your debt-to-income ratio by including the guarantor loan liability, even if you're not paying the EMIs. This reduces the amount you can borrow and may result in less favourable terms. Here's a detailed outlook:

Things to Consider Before Becoming a Guarantor

Borrower Considerations

Do not guarantee a loan without previously evaluating the borrower’s financial health. As part of this, have a look at their income, any existing obligations, debt servicing, as well as repayment patterns. Emphasise the importance of sharing their credit report; investigate why they may have a poor credit history to understand if they tend to be financially irresponsible.

Personal Considerations

In addition, you must make sure you will be financially capable of repaying the loan should the worst come to be. You should already have a high credit score, and your credit history must demonstrate creditworthiness and responsible repayment behaviour. Without these, the loan application may get rejected. Seek professional advice from financial advisors if needed. Proceed only when you're fully certain about repayment outcomes and with the willingness to assume the loan in the worst case.

Exit Strategies and Limitations

Exiting a guarantor agreement isn’t simple or straightforward once you've signed the loan agreement. Most banks require you to stay as a guarantor unless the borrower either finds a better guarantor or provides more collateral. The process still involves a lot of legal paperwork and approvals, which extend the duration to several months.

In case the borrower dramatically improves their financial situation, the bank can be asked to remove the guarantor, which is rarely successful, and the borrower would need to repay large portions of the loan as a guarantee to the bank.

Also Read: Essential Financial Tips for Managing Mortgage Loans Effectively

How to Make an Informed Decision

It's advisable to ask yourself these questions before you make your decision:

The decision to guarantee a loan should lead to staying in constant communication with the primary borrower. Set clear expectations and ask for regular progress reports, including copies of payment receipts. Consider setting up automated alerts through banking apps to monitor the loan account. Some guarantors even maintain a contingency fund equivalent to 6–12 months of EMIs as a safety net.

To Conclude

The implications of being a loan guarantor go far beyond just helping another person secure their credit. Remember that saying no to a guarantee request, while difficult, might preserve both your financial health and personal relationships. Consider alternative ways to help, such as contributing to the down payment or helping improve the borrower's credit score through proper financial planning.

Poonawalla Fincorp offers a range of financial solutions with competitive interest rates and flexible tenures. Contact us to understand your credit position and explore suitable lending options that align with your financial goals.

Frequently Asked Questions

Does being a guarantor affect CIBIL score?

Yes, becoming a guarantor for a loan can impact your CIBIL score, especially if the borrower defaults or delays payments. The loan amount is reflected in your credit report as part of your financial responsibility; by extension, it reduces your debt-to-income ratio.

Can being a guarantor affect me?

Absolutely. As a loan guarantor, your credit score, borrowing capacity, and loan approval chances can be impacted. If the borrower fails to repay, you're expected to take on the entire loan amount alongside any other penalties or fees. Taking on this responsibility is a long-term decision with major impacts.

What if the guarantor cannot pay?

Failure to repay could result in legal action, damage to the guarantor's credit score, and potential seizure of assets. The damage is long-term, and it could take years to recover the credit score. Additionally, the equation between the primary borrower and guarantor is likely to face strain from the situation.

What are the criteria for being a guarantor on a loan?

A guarantor must have a good credit history, stable income, and meet the lender’s loan approval standards. Lenders assess whether the guarantor acts as reliable financial security if the borrower defaults; these are some of the factors they examine.

Who can be a guarantor for a loan?

A personal guarantor can be a family member, friend, or colleague. The key requirement is that the person must have a good credit history and sufficient financial capacity to take on the financial responsibility if the borrower defaults.

Does the borrower's default affect the guarantor's credit score?

Yes, being a loan guarantor can impact the guarantor's credit score if the borrower defaults on the loan. The guarantor is held financially responsible, and missed payments reflect in their credit report.

Does having a loan guarantor affect interest rates?

Yes, the presence of a guarantor can result in lower interest rates for borrowers. The guarantor serves as additional security, making it easier for lenders to offer lower rates. In this way, the guarantor helps both the borrower and the lender.