Saturday, June 4, 2011

Being a Guarantor

Should you be a guarantor ?
Take on the financial commitment only if you have the ability to repay a loan if the borrower defaults.

Guaranteeing a loan is vastly different from signing a document as a witness. When you agree to become a guarantor for a loan, you are making a financial commitment, one that should be done only after considering all the aspects. This is important because if the borrower defaults on the payment, the responsibility of the loan has to be borne by the guarantor. In such a case, there is little a guarantor can do except talk to the lender and try to make a settlement for future payments of the remaining debt

When a person signs on as a guarantor, he becomes as liable to repay the loan as the principal borrower. According to the law, if the borrower defaults and is untraceable, the guarantor has to pay the outstanding debt. If need be, his assets can be sold to clear the debt.

Banks insist on guarantors for the loans in which there is no appropriate collateral, such as education and business loans.For other loans too, banks can insist on one, especially if the borrower does not have a good credit history. Other instances where a guarantor is needed are if the borrower has a transferable job or one which involves frequent travel abroad. It's also necessary when the loan is applied for in a city other than the one that is the applicant's permanent address.

While a guarantor need not service a loan on a monthly basis, the loan repayment can have an impact on his credit history. In case of a default, not only will he be asked by the financial institution to pay, but a default on his part while repayment the loan will also be reported to the credit bureaus.

Even if the EMIs are being paid regularly and on time, the relationship of the guarantor and the borrower could affect his own borrowing capacity. For instance, if a friend is a guarantor, he will be able to take a loan independently. However, if the guarantor has a closer relationship, such as a wife, she will have to shoulder a quasi liability. The means that if she wants to take a loan, her borrowing capacity will be calculated after accounting for the original loan that is being repaid.

Also, the liability of the guarantor usually terminates only after the loan has been fully repaid. If you are signing up for a home loan guarantor, be prepared that it will impact all your other financial borrowings for the next 10-20 years. So if you do want to help someone in need, it would be better to opt for short-term loans, such as car and education loans. 

In case you want to be relieved of your responsibility as a guarantor, review the guarantee deed and conditions of revocation. Usually, you can revoke it by giving a notice in writing to the lenders as well as  the borrower. The lender will then check the borrower's financial condition and the original arrangement. However, relieving a guarantor is solely on the lender's discretion. The bank's rationale is that the guarantor cannot shirk his responsibility mid-way as he had initially offered the guarantee for the full tenure of the loan.

However, revocation can be considered in certain cases. You can opt for it if an additional loan has been granted to the borrower without your consent, such as a top-up loan. You will, however, only be relived of the second loan and will be liable until the original amount of the loan has been repaid. The other options include you providing a substitute guarantor with the consent of borrower, or prepayment of the loan by the borrower.

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