Loan guarantor: How saying yes can affect your finances and credit score

New Delhi: Becoming a loan guarantor for someone is a major responsibility as well as a matter of caution. When you agree to sign a guarantee document for someone who has taken a loan, it comes with its own implications.

When a person borrows money, he/she approaches either a close friend or a family member to become the guarantor. In such a situation, the other person may find it difficult to refuse due to a sense of responsibility. While it is one's own call to accept or reject, one should be cautious while agreeing to be a part of it.

Being a guarantor means being co-extensively responsible for the borrower's debt and overdue payments. Section 128 of the Indian Contract Act specifies that the liability of the guarantor is co-extensive with that of the principal debtor, unless the contract states otherwise. It means that the creditor need not exhaust all the methods of recovery against the principal borrower before approaching the guarantor. If the creditor considers the borrower incapable of repayment, the guarantor may be asked to clear the dues.

The liabilities of the borrower include the principal amount, accrued interest, and penalties, and the guarantor is co-extensively responsible for covering these portions of the repayment.

Another consequence of being a guarantor for someone incapable of repayment relates to one's own profile as a borrower. Banks and financial institutions gauge the repayment capacity of a person before approving a loan. While a guarantor may not actually be at fault for a default on a loan taken by the principal borrower, both stand at the same position in terms of liability. Any default by the borrower reflects on the guarantor's loan eligibility since guaranteed loans are treated as contingent liabilities.

Also, when a default arises, credit bureaus may consider borrowers and guarantors as equally liable, which can have a significant impact on the credit profile.

The lender may take legal action against not only the borrower but also the guarantor in case of default. Even if the financial circumstances are actually difficult for the two, legal consequences would follow.

Before agreeing to be a guarantor for a friend or a family member, understand the person's financial standing. If the person seems incapable of making timely repayments, it is better to say no.

You may check the person's repayment history and gauge financial stability based on it. Also, read the agreement carefully and understand your responsibility as a guarantor and the consequences that may arise. Stay in touch with the borrower, keep checking the loan repayments and stay updated regarding your own credit score. It is better to be cautious and do what is necessary on time, instead of suffering later.