What is a Loan Guarantor? Responsibilities and Risks

Summary

A loan guarantor is someone who assures repayment of a loan in case the borrower defaults. The lender requests a guarantor when the borrower has a bad credit score, unstable income, or no credit history. This provides extra security to the lender, who is assured that the loan will be repaid. Student loans, home loans, business loans, and individual loans are certain common loans involving a guarantor.

As much as all that is mentioned, being a guarantor also includes some risks like money liability, undermining of credit standing, and liability for prosecution if default occurs. Upon default, should the borrower miss payments, the lender has every right to ask the guarantor to repay what is outstanding and this could spell financial trouble while also interfering with future access to credit.

To safeguard yourself as a guarantor, there is a need to carefully review the terms of the loan, verify that the borrower is solvent, cap your liability, and track loan repayment. If you do not desire to remain as a guarantor, you can seek to remove yourself by asking the lender, finding an alternative guarantor, or requesting the borrower to refinance the loan. After the loan is completely paid off, it is essential to get a No Objection Certificate (NOC) to ensure that your liability has ceased.

Introduction

Suppose your friend needs to borrow a loan but has no good credit history. The bank requests a guarantor—somebody who will repay the loan if your friend cannot. That is what a loan guarantor is. A loan supporter is an individual who legally promises to repay the loan in case of default by the main borrower. Although it might appear to be a straightforward gesture of friendship or trust, becoming a guarantor involves heavy financial obligations and liabilities.

When one applies for a loan, financial institutions or banks take into account his or her credit rating. If the loan applicant has a poor credit rating, messy income, or thin financial history, lenders might request a guarantor so that they can minimize their risk. The guarantor is there to offer extra security to the lender. It assures the lender that the loan will be paid back, either by the borrower or, if need be, by the guarantor. This is a common practice in personal loans, housing loans, education loans, and even business loans.

Yet being a loan guarantor is not only a process—it is also a contractual responsibility. When the borrower fails, the guarantor will become liable for the loan. It may affect the guarantor’s financial stability and credit rating. In cases where the loan is not repaid, the lender may sue the guarantor before a court of law with dire financial repercussions.

Apart from the financial loss, being a guarantor also affects the borrowing limit of the person. Since the loan amount now forms part of the liability on the books of the supporter, it will restrict them from getting a personal loan or a housing loan in the future.

What is a loan guarantor?

A guarantor is an individual who promises to repay a loan in case the primary borrower defaults. If an individual applies for a loan but has a poor credit rating or irregular income, the bank can request a supporter to minimize the risk.

The guarantor enters into a legal contract that if the borrower fails to repay the loan, they will take over and make the payments. This is a financially risky role because if the borrower defaults, the guarantor’s credit rating can be impacted, and they might even be taken to court.

Why do lenders require a guarantor?

Lenders ask for a guarantor when they believe the borrower might not be able to repay the loan independently. This typically occurs if the borrower has a poor credit score, unstable income, or no credit history.

This decreases the risk for the lender and provides a greater opportunity for the loan to be approved. Essentially, having a guarantor assures the lender that they will receive their money, either from the borrower or the supporter.

What are the key responsibilities of a loan guarantor?

The most important duties of a loan supporter are:

• In case the primary borrower fails to repay the loan, the supporter is liable to pay it in full.

• The guarantor is to monitor the payments of the borrower’s loans to prevent default.

• To sign as a guarantor is to formally agree legally to repay the loan if required. This will influence the credit status and record of the supporter.

• Because the guaranteed loan is treated as a liability, it could diminish the guarantor’s access to obtaining their loans.

• The guarantor should read and comprehend all loan terms before signing to prevent unexpected hazards.

Which types of loans commonly require a guarantor?

Certain loan types where lenders tend to request a guarantor are:

1. Education Loans – Students lacking a regular income can require a supporter, who is typically the parent, to obtain a loan for further studies.

2. Home Loans – Banks can request a guarantor if a borrower has an inferior credit rating or an unstable income to sanction a home loan.

3. Personal Loans – Individuals with low income or bad credit records might require a guarantor to secure a personal loan.

4. Business Loans – Small businesses or startups frequently require a supporter, provided the borrower has no good financial record.

5. Vehicle Loans – In case an individual wishes to purchase a car or bike but has a poor credit score, the lender might demand a guarantor for loan approval.

Who Can Be a Loan Guarantor?

The following individuals can be loan supporters:

• Family Members – Parents, spouses, or siblings usually serve as guarantors, particularly for education or house loans.

• Friends or Relatives – A relative or a close friend may be a guarantor provided they trust the borrower and are acceptable to the bank.

• Employers – Employers can be guarantors for their employees in certain instances, particularly for business or personal loans.

• Business Partners – In case a business is borrowing money, a co-founder or partner might be asked to personally guarantee the repayment.

What Are the Risks of Being a Loan Guarantor?

Being a loan supporter has many risks, including:

• In case the borrower does not repay the loan, the guarantor will be responsible for paying it in full.

• If payments are missed or there is a default, the credit score of the guarantor will also be damaged.

• Legal action can be taken against the supporter by the lender if the loan is not repaid.

• Becoming responsible for another person’s loan can strain the guarantor’s finances.

• As the guaranteed loan is considered a liability, the guarantor might have trouble securing the loan in the future.

What Are the Rights and Responsibilities of a Loan Guarantor?

Rights and Obligations of a Guarantor of a Loan

Rights of a Guarantor of a Loan:

• The supporter is entitled to all information regarding the loan, including repayment conditions and risks.

• No one can compel an individual to act as a guarantor; it is voluntary.

• If the lender makes changes to loan terms without informing the supporter, they can take legal action.

• Upon going through the entire loan repayment, the guarantor can request the lender for a No Objection Certificate (NOC) to confirm that its obligation is fulfilled.

Duties of a Loan Guarantor:

• In case of default by the borrower, the supporter has to repay the loan.

• The guarantor should see that the borrower pays punctually.

• Any default in payment by the borrower can lower the guarantor’s credit score.

• As the guaranteed loan is a liability, the guarantor’s future loan approvals can be affected by it.

How Can You Protect Yourself as a Loan Guarantor?

Being a loan supporter is risky, but you can protect yourself by doing the following:

• Read all loan documents carefully before signing to know your responsibilities.

• Ensure that the borrower possesses a solid income and favorable payment history.

• If possible, request the lender to limit your financial obligation rather than guaranteeing the entire loan amount.

• Check periodically if the borrower is paying on time to be surprised.

• Have a signed undertaking with the borrower that they will pay the loan on time.

• As soon as the loan has been repaid, obtain a No Objection Certificate (NOC) from the lender certifying that your status as a supporter stands closed.

• Be a guarantor only if you are financially healthy and have the utmost confidence in the borrower.

Are There Alternatives to Being a Loan Guarantor?

Some of the likely alternatives are:

• Collateral-Based Loan – Instead of a supporter, property, gold, or fixed deposits can be provided as collateral against the loan.

• Co-Signer Option – A co-signer is allowed by some lenders, where the co-signer will have responsibility for the loan but with more authority than a guarantor.

• Improved Credit Score – The lender can make a move to improve their credit score before applying, therefore no guarantor is needed.

• Applying for Smaller Amount Loan – A smaller amount loan provides maximum chances of approval without necessitating a guarantor.

• Applying for Government-Backed Loans – Some government schemes offer loans with lower risk, and therefore a guarantor may not be required.

How to Remove Yourself as a Loan Guarantor?

If you do not want to be a loan supporter anymore, do the following to step out:

• Read the loan terms to see if one can withdraw as a guarantor.

• Ask the lender or bank if they allow the removal of a guarantor. The lender may accept this if the borrower has been making payments according to schedule.

• If the lender allows it, you can have a new guarantor in your stead.

• The borrower may take a new loan without a guarantor and use it to pay off the current loan.

• When you pay off the loan completely, you are automatically exempted from guarantor status.

• When the loan is paid off, ask the lender for an NOC to prove that you are not a guarantor anymore.

Conclusion 

Being a guarantor is a serious financial commitment that must be approached with caution. While it may assist a relative, friend, or business contact in procuring a loan, it can be risky. If you are a guarantor, you would be legally obliged to repay the loan if the borrower fails. This may affect your future credit score, personal finances, and capacity to borrow.

Guarantors are generally asked by the lenders if the borrower has a poor credit history, fluctuating income, or no credit history. This will help the lender recover the loan even if the borrower fails to do so. Education loans, home loans, business loans, and personal loans can require a supporter. B before signing, one must know one’s rights and obligations as well as the hazards involved.

If you are going to be a guarantor, you would like to exercise care in protecting yourself. This involves going through the loan agreement carefully, ensuring the borrower’s financial record is good, and monitoring repayment on the loan periodically. Alternatives are also available, such as providing collateral-backed loans, co-signing accounts, or government-insured loans which do not require a supporter.

Frequently Asked Questions (FAQ’s)