How guaranteeing a loan can affect your credit score and history

By Sanjay Patel

Nowadays, access to your house or car or that dream holiday has been made easier by lending companies offering credit and loans at increasingly competitive rates. However, one must note that taking a loan doesn’t solely depend on the borrower’s financial standing. If lenders feel that the financial health of the end borrower cannot be determined standalone, or in case the borrower has no source of income, another option to get a loan processed includes involving a guarantor. Apart from facilitating an individual to fund his education or business, such an arrangement propels financial inclusion, thereby enabling the economy to grow holistically.

Naturally, for a financial institution, it is of paramount importance to make sure that the borrower has the capacity to repay the loan with due interest. In case the primary borrower defaults, a guarantor’s role is extremely crucial, as they become the fall-back option for the lender. Lenders insist on guarantors for loans in which there is no appropriate collateral, such as education and unsecured instalment loans. For other loans too, lenders can insist on one, especially if the lender has a reservation on the repayment ability of the primary borrower. Data shows that loans backed by guarantors have lower default rates than the average of the portfolio in products like commercial vehicles. Hence, the creditworthiness of the guarantor is of substantial importance.

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In India, several loan accounts, specifically education loans, are backed by guarantors. In the case of education loans, over 80 percent of the loans are booked with guarantors since the primary borrower would not be earning for the duration of his/her education. In most cases, a loan gets approved at the behest of a guarantor, who indirectly assumes the responsibility of furnishing the loan though he is not the end borrower. Guarantors are legally responsible to assume the liability if the primary borrower defaults. A guarantor’s role doesn’t end with the disbursal of the loan; this is where the responsibility actuality just begins. There are several issues that guarantors need to know, who choose to be good samaritans for their friends’ or family members’ cause.

Most importantly, a loan sanctioned will directly impact the guarantor’s credit report and score. Though a guarantor might be financially prudent and disciplined in paying his or her own equated monthly installments (EMIs), credit card bills, the friend or relative who they are backing might not emulate that same responsibility. Should the friend or family member miss a payment or make a late payment, the guarantor’s credit history and score would be negatively impacted. Therefore, one should keep in mind that the moment they sign as a guarantor for a loan, it shows up in their credit report with a clear indication that they are the guarantor. The guaranteed loan will reflect on the guarantor’s credit report and will be used by the lending institution when eligibility for a loan is calculated.

Additionally, it is advised that the following facts are taken into consideration before signing up as a loan guarantor. One must also remember that a guarantor cannot take a stance on deciding the limit of liability towards the loan. The very purpose of getting a guarantor for a loan is to make sure that the bank has an alternate source of recovery if the principal debtor defaults. So, one must not always go by the credit repaying capability of the end borrower alone. Instead, a guarantor must calculate his own financial capability before signing up.

At the same time a guarantor needs to bear in mind his own financial goals. If the prospects of purchasing a new home or starting up a business are on the horizon, the guarantor should stick to backing small loans that will not weigh heavy on a credit report. A financial institution might refuse credit or might reduce the amount of credit to the guarantor if he or she is already backing another loan of a fairly large amount. If at all one has to become a guarantor, getting another guarantor to go in on the loan, as the liability could then be split between the two guarantors. The strength of the relationship with the primary borrower based on which one becomes a guarantor needs to be borne in mind as especially in long term loans.

There have been cases where a guarantor has been penalized for the principal applicant’s delinquency. Hence, it is not wrong to assume that a guarantor’s liability could be more than the principal borrower’s. Even if the guarantor has a good track record of repayments or good credit history, a delinquency could act as a deciding factor for creditworthiness when banks access credit reports. So before signing on the dotted line, a guarantor should weigh all of the pros and cons associated with the financial backing of friends and family.

The author is managing director and chief eexcutive officer, Equifax Credit Information Services