Guaranteeing a home loan can land you in trouble

Understand the finer points before signing on the dotted line as a guarantor, says Rajiv Raj

Ashish was surprised when his car loan application was rejected due to a low CIBIL score. He had been a meticulous borrower who had always paid his dues on time. On checking his credit report he found out that he had guaranteed a loan for his brother a couple of years ago. His brother had been late in making a couple of payments which was reflected in his credit report too. Ashish knew that he was responsible for payments if his brother defaulted but he did not know that a loan that he guaranteed was linked to his credit report too. So just like Ashish, don’t ignore the finer points when guaranteeing a loan.

Guarantor is liable to pay if the borrower defaults

The guarantor of a loan is expected to pay the loan if the borrower is unable to do so or willfully defaults on repayments. So when you guarantee a loan you are legally bound to pay the loan EMIs when the principal borrower does not do the same as you are guaranteeing on behalf of the borrower.

It is important to understand that by pledging as a guarantor on the loan, you are also legally responsible towards the timely repayment of the loan. A guarantor pledges to repay a loan on behalf of the principal borrower who has taken the loan. If the principal borrower passes away then also the guarantor may be called upon to repay the remaining loan amount; this however will depend on the exact clause in the loan agreement.

Guarantor has no right over the asset

This is a fact that often puts a guarantor in a tricky position; while he is liable for the loan repayment he has no right whatsoever over the asset. This is also one of the prime differences between being a co-borrower and a guarantor. While a co-borrower can be a co-owner the guarantor cannot be so.

A co-borrower is jointly responsible along with the primary borrower to repay the loan and guarantor is called in after the primary borrower defaults. Thus in case the co-borrower is forced to bear the burden of a loan, s/he can rest assured that s/he owns a part in the asset. This right is not available to the guarantor who has the responsibility of repayment and no ownership of the asset. Thus it is imperative that one is very sure about the person for whom they agree to be a guarantor. It is not a responsibility that can be taken lightly.

The loan is linked to the credit report of the guarantor

Just like your own loans and credit card details reflect in the credit report, the details of a loan that you have guaranteed will also do so. While each time the borrower defaults the guarantor is not asked to come and pay the EMI, each delay or default will surely impact the credit score negatively. The guarantor is asked to pay if the principal borrower has not paid after repeated reminders but the minute there is a delay in payment it will surely lower your credit score. So just like Ashish you might be surprised to see a low score despite never having defaulted on your credit card and loan payments.

There is no rule which says whether one should guarantee a loan or not; it will depend on the situation and the relationship and trust shared by the principal borrower and guarantor. In some conditions a guarantor can be a life saver for the principal borrower who may not get a loan otherwise. The important thing is to understand all aspects well before doing so and then make an informed decision.

Illustration: Uttam Ghosh/Rediff.com

The author is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.