When Does Bank Ask For A Guarantor?

10-Jan-2017 written by : FSI-Team

Dilip Doshi still shudders remembering the day when he agreed to sign as guarantor to an ex-colleagues personal loan application. Little did he know that in doing so he was risking his own credit health. When his colleague started missing payments, the bank approached Dilip to repay the debts as he had guaranteed the loan, something Dilip was not prepared for. Even after selling the principal borrower's assets to recover the loan, Dilip had to shell out over a lakh of rupees to settle the loan completely. An experience such as this can leave any one with a bitter taste in the mouth.

Why Banks Ask For A Guarantor?

Clearly banks ask for a guarantor when they are not comfortable with the principal borrower's own ability in meeting the debt's obligations. Many banks ask for a guarantor and it is a misconception that only PSU banks ask for personal guarantors. It can be any credit institution such as a NBFC. They ask for third party guarantees depending on individual applications, type of debt, internal credit policy etc.

Usually they seek a personal guarantor when:

  1. The applicant falls short on credit health parameters.
  2. The borrower has an unstable employment, is frequently transferred to different locations
  3. The sector in which the applicant works does not guarantee job stability
  4. Lack of proper academic background
  5. Uneven stream of income which discomforts the lender into doubting the capacity to repay
  6. When borrower is purchasing a home at a location other than place of residence.
  7. There are no co-applicants on the loan.
  8. The borrower is transferring the loan from one bank to another.

These are some cases where the bank might insist on a third person to stand as a guarantor. The guarantor must meet the norms as specified by the lender. Banks feel more comfortable when there is a person who "guarantees to the bank that incase the principal borrower fails to repay the loan then, you will make good the losses". This way the bank feels way more comfortable in lending as their interests are safeguarded. A personal guarantor is a form of "human" security.

Loan guarantors hold a secondary responsibility towards the loan, the primary being that of the principal borrower and the co-applicant. Only if there is a default, the liability transfers to the guarantor.

Banks prefer blood relatives and in-laws to become guarantors but they may at times even allow friends and colleagues too. Apart from KYC documents, your credentials will be checked - your income, outstanding liabilities, value of current possessions etc. will also be evaluated. You will be asked to sign an agreement on a stamp paper, making you legally bound to your promise.

What Should You Know Before Becoming A Guarantor?

Before you unwittingly sign the dotted line to stand as guarantor, take a look at the tumultuous responsibility that comes along with it. It is not just a verbal assurance to the lender that the borrower will fulfil the debt obligation. Infact you have promised to shoulder the responsibility of the loan if the primary borrower fails. Make note of following things before you nod:

  1. Your own eligibility will be impacted by the extent of the loans you have guaranteed. Banks look at overall indebtedness of the applicant. If your credit report reveals that you have guaranteed a loan, no matter whose, then your own eligibility will be reduced by that amount. Because if there is a default on that loan then your primary obligation will be towards that loan which you have guaranteed and secondary towards your own lenders.
  2. If you deny or fail to repay the bank then the bank can attach your personal assets to recover the loan.
  3. Know that the exit route is not simple. Infact once you become a guarantor you cannot shake off the responsibility by simply approaching the bank. Only the borrower himself or herself can apply to excuse you from the responsibility.
  4. Whether the lender agrees to that is solely at its discretion. Supposing the guarantor is looking to apply for a home loan and would want to be relieved of being a guarantor then he or she can ask the primary borrower to apply to the bank. The borrower may have to provide with additional security or another guarantor. Yet, the bank may or may allow the change in guarantor.
  5. You may exit at a time when things have been running smoothly. You cannot exit being a guarantor when you have been sent a notice to repay. If the bank senses that the borrower may shed off the responsibility, they may not let go the guarantor at all.
  6. As a guarantor you can ask the bank to sell the properties of the borrower to recover the dues. But if liquidating assets is not enough to cover the losses then they will recover from the guarantor.
  7. If the guarantor repays all outstanding dues to the bank, all the borrower's properties can be transferred to the guarantor. The guarantor can settle dues with the borrower separately.
  8. Even if the principal borrower has passed away or is permanently disabled, the liability shifts to the guarantor. See if the borrower has a life insurance policy or a home insurance policy that will cover the debt incase of default. Look at minimising personal risks first.
  9. Defaults have the potential to spoil the CIBIL score of not just the borrower but also that of the guarantor.

Don't let your emotions get the better of you. If the bank has asked for a guarantor then possibly they doubt the borrower's capacity to repay. Don't let someone else spoil your credit health and you must choose to guarantee only for family members, say experts.



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