All About Guarantor


What is a Guarantor?

A guarantor is someone who assures the lender that if the primary borrower defaults, they will repay their debts out of their own pocket. In order to provide assurance, the guarantor may pledge their personal assets or other crucial documents to the lender.

KEY TAKEAWAYS

  • A guarantor assures the lender of debt repayment if the original borrower defaults.
  • The liability of the guarantor is pre-defined if the borrower defaults.
  • If, as a guarantor, you fail to meet your obligations, you may face legal ramifications.

Why do lenders ask for a guarantor?

The following are the most common scenarios in which the lender requests a guarantor.

  • If you have only recently begun your career but are in desperate need of funds, the lender will require you to provide a guarantor in order to approve the loan. This is because, in the usual course, the lender typically requires applicants to have six to twelve months of work experience.
  • If you have a steady job but have never applied for a loan before, the lender will expect you to provide a guarantor when you make your first loan application. Since lenders have no way of determining your sincerity in terms of repayment, they require assurance that their funds are secure, which the guarantor provides.
  • If you have a history of skipping EMIs or delaying credit card dues, your credit score will be average. Now, if you want to apply for a new credit line with an average credit score, the lender will need security in the form of a guarantor.
  • If you work in a business that only thrives during a specific season or festival, or if you change jobs every two to three months, the lender will view you as a high-risk borrower. They will only lend you money if you provide collateral, add a co-applicant, or introduce a guarantor to your application.

Who all can become a guarantor?

You can introduce anyone as a guarantor on your loan application or for other purposes, such as rent agreement, passport verification, etc. A guarantor can be your spouse, close relative, siblings, parents, or a friend. If you are introducing a close family member as a guarantor, make sure you both have separate bank accounts rather than only having a joint account.

Before asking someone to be your guarantor, ensure that they are over the age of 18 and have a stable job with a good income. Examine their credit history as well. If the guarantor has poor credit, the lender will not accept them as a guarantor and may reject your loan application.

As a responsible borrower, you must communicate with the guarantor about the consequences they may face if you default. Also, inform them beforehand of any potential risk associated with your profile.

Types of guarantors

Guarantors are typically classified into four types, which are listed below.

1. Guarantors as certifiers

Guarantors do more than just pledge their assets to help you secure funds. They can also help you find work or provide you with documents that will speed up the process of obtaining a passport. As a certifier, the guarantor confirms/assures that they know you personally and that you will not commit any malpractice while on the job.

2. Limited or unlimited guarantor

The terms and conditions of such a type of guarantee are pre-specified in the loan agreement. If you choose to become a limited guarantor, your liability in the event of loan default is restricted. For example, suppose you become a guarantor for a friend who obtained a ₹5 Lakh Personal Loan, and the lender fixed your liability as a guarantor to 20%. If your friend defaults, the borrower will hold you personally liable for ₹1 lakh.

On the other hand, if you become an unlimited guarantor, you will be held liable for the entire unpaid amount if the primary borrower defaults.

3. Secured or unsecured guarantors

This type of guarantee is related to the pledging of assets. If you choose to become a secured guarantor, you must pledge your asset to the lender, who will have conditional ownership of it until the primary borrower repays the debt. They have the authority to seize assets in the event of a default in order to recoup their losses.

4. Other Contexts for Guarantors

Borrowers do not always require a guarantor to cover their poor creditworthiness. For example, if your child is living in another city to pursue higher education, you may become a guarantor on the rent agreement. If your child violates the agreement or fails to pay the rent on time, you may be held liable to compensate the landowner.

Guarantor vs co-applicant

Parameters Guarantor Co-applicant
EMI obligations As a guarantor, you are not responsible for paying the EMIs in normal circumstances. As a co-applicant, you are equally responsible for EMI payments as the primary borrower.
Rights on goods You have no right to the property purchased on finance. Co-applicants have an equal or proportional interest in the goods or property financed through the loan.
Obligations on default In the event of a default, you must repay the outstanding balance by the terms of the loan agreement. If there is a default, you will face the same consequences as a primary borrower.

Things to bear in mind before you guarantee a loan

Before becoming a guarantor on someone else’s loan application, you must first consider the following points.

  • Borrower’s creditworthiness:
    You must review and analyse the borrower’s credit report, regardless of who they are. If you discover that the borrower has previously defaulted on the loan or has a pattern of delaying EMIs, you should reconsider your decision. This is because the likelihood of default with this type of profile is high.
  • Loan in future:
    If you wish to apply for a loan in the future, especially a large one, avoid becoming a guarantor. This is because when you become a guarantor on someone else’s loan application, the lender takes your liability as a guarantor into account when determining your repayment potential. The situation has ramifications for your future borrowing capacity and may result in loan application rejection.
  • Know the reason:
    Always inquire as to why the borrower requires a guarantor. The borrower is likely to struggle with debt repayment if the reason is a low salary, job insecurity, or a higher debt-to-income (DTI) ratio. The scenario could also lead to a loan default. As a result, it is preferable to decline such an applicant for the position of the guarantor to avoid any future consequences.
  • Have a contingency fund:
    Even if you are aware that the primary borrower has a poor credit history, you cannot refuse to become a guarantor in certain situations. This type of situation is common when you become a guarantor for your spouse, parents, or child. In such cases, one should have a contingency fund ready to use for debt repayment if the original borrower defaults.

Advantages of a guarantor

Having a guarantor on your side has several perks, but the three most important ones are outlined below.

  • Affordable rates:
    In case you barely meet the lender’s minimum loan eligibility criteria, you may get loan approval but at a higher interest rate. However, if you can provide a guarantor with a good credit history, you may be able to qualify for a lower interest rate. Furthermore, if the guarantor is willing to pledge their assets, you may be able to negotiate better terms with your lender.
  • Ease in getting an apartment:
    If you have a history of eviction, late rent payments, or no previous rent record, a guarantor can help you obtain a rental property without difficulty.
  • Higher LTV:
    Loan to value or LTV is a percentage of the property’s value that your lender disburses in the loan. Assume you are applying for a home loan, but your gross profit from your business or salary income only qualifies you for a loan with an LTV of 50%. If you can add a guarantor with unlimited liability, your lender is more likely to increase your LTV ratio.

Disadvantages of a guarantor

The consequences of becoming a guarantor depend primarily upon the guarantor type. There are no such disadvantages if you sign as a non-financial guarantor. However, in the case of a financial guarantor, the list of cons is extensive, and a few of them are listed below.

  • Personal possessions at risk:
    In the event of a default, the lender will approach the primary borrower first to settle the loan. If they are unable to do so, the lender will ask you to pay the dues. Moreover, if your financial situation does not allow you to do so, the lender may seize and auction your personal belongings to recoup the unpaid amount.
  • Drop in credit score:
    When your name appears as a guarantor on someone else’s application, and they are not disciplined with repayment, your credit score will suffer. As a result, if you apply for a loan in the future, the lender may not approve you for favourable terms.
  • Credit usage:
    When you sign on as a guarantor, credit bureaus place a lien on your personal credit line. It means that your borrowing limit is significantly reduced, and you may not be able to withdraw the entire amount from your revolving credit line that you were previously eligible for.

What if the guarantor cannot pay?

The loan agreement clearly states the guarantor’s rights and responsibilities. If you choose to become a secured or non-limited guarantor, you risk losing your pledged assets or personal belongings. This happens if the primary borrower defaults and you are unable to repay their dues. In the worst-case scenario, the lender may also drag you to court with the motive of loan settlement.

Failure to meet your obligations as a guarantor will result in a deterioration of your credit score. You will also have difficulty obtaining a visa and renting property, among other consequences.

Final words

A guarantor promises to pay the outstanding dues if the borrower defaults on a loan. Having a guarantor on your loan application can help you get approved even if your credit is average and your income is low. Before signing as a guarantor on someone else’s application, make sure you understand your liabilities and the consequences of default.

Other Words

  • Gross Profit

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