Imagine this. A very close friend of yours applies for a home loan or any other loan that requires a long term commitment. He is your childhood friend and you know for a fact that he is a responsible person. However, when he applies for the loan, his credit score is not satisfactory, and the bank insists on guarantor to process his loan application.
Knowing that you are there by his side through thick and thin, he approaches you to be his guarantor instead of considering other possibilities such as a loan for low CIBIL score . You think that it is only for the sake of paperwork and are confident of his repayment capabilities. You therefore go ahead with the formalities of providing guarantee. But did you know that by doing so, you are putting your loan eligibility at stake? Here is what happens when you sign up as a guarantor.
A lender is not under obligation to exhaust all options of recovery in case of a loan default before it approaches you. After issuing a few warnings to the primary borrower, the bank is at liberty to ask you to pay an instalment or two upon his behalf. Worse still, if he goes missing from the scene, you are deemed responsible for the outstanding debt. Therefore, if indeed you are deciding to sign up as a guarantor, assess your friend's loan repayment capabilities thoroughly. It is a good idea to go through his CIBIL report to get an idea about how he has handled credit in the past.
When you sign up as a guarantor, you are effectively making a declaration to the bank that you will take up the responsibility of repaying the loan on behalf of your friend in case he is unable to do so. Thus, when you provide this guarantee, it impacts your own credit score and loan eligibility. In case, you need to take a line of credit, your prospective lenders may be sceptical of approving your loan application in case you have given the guarantee to repay your friend's loan. In case of the guarantee for a home loan or a business loan, which are long term commitments, you may not be able to get a similar loan yourself. Thus, if you indeed wish to stand in as a guarantor for a friend or a family member, ensure that you do not need to apply for a long term loan yourself.
You may have had a stellar credit score and a blemish Free CIBIL report so far, but when you provide guarantee for a loan, your own credit score takes a hit, the moment the application is processed. This is because the lender is providing the loan to your friend based on your financial position. Further, the records of the same shows up on your report and remains there till the loan has been repaid in full. Any default on the loan, has a direct impact on your credit score.
If the bank is insisting on a guarantor to approve a loan that your friend or relative has applied for, it is likely that his credit score is not up to the mark, and the bank has assigned a greater risk factor in providing the credit line that he has applied for. In such a case, it is prudent to take a rational decision rather than being guided by emotions. If his credit score is not up to the mark, you can suggest that he applies for a loan for low CIBIL score instead. It may mean that he may not get a loan from a traditional lender and processing of the loan may come after some extra bit of paperwork, but it will take care of his financial need.
If he is really your friend, he will listen to you and take your advice rather than getting upset about you not standing as a guarantor for the credit line he wishes to take. Whatever may be the case, keep a calm head over your shoulders.