Often, in order to maintain friendship, kinship or family ties, we sign as 'Loan Guarantor' in an acquaintance's home loan, car loan or personal loan without thinking. Most people think that becoming a guarantor is just a paper formality and the entire responsibility of repaying the loan rests only with the person who has taken the loan. But the rules of banking and credit bureau are completely opposite to this. If the primary borrower does not pay his EMIs on time or defaults on the loan, it has a direct and serious impact on the CIBIL Score of the guarantor and his ability to avail the loan. In such a situation, it is very important for any person to understand the rules of Reserve Bank of India (RBI) and Credit Bureau thoroughly before signing the loan documents as a guarantor.
Under Section 128 of the Indian Contract Act, 1872, the liability of a guarantor is co-extensive with that of the principal debtor. In simple words, in the eyes of the law and the bank, the guarantor is as responsible as the main person taking the loan. As long as the principal borrower continues to pay his EMIs on time, there is no negative impact on the CIBIL score of the guarantor, although the loan does get recorded as a 'guaranteed loan' in his credit report. But as soon as the main borrower misses three consecutive EMIs (90 days) and his account falls into NPA category, the bank sends the details of the main borrower as well as the guarantor to credit bureaus like TransUnion CIBIL, Experian and Equifax. As a result, without any fault of the guarantor, his credit score starts falling rapidly and his credit history gets spoiled.
A major disadvantage of becoming a guarantor for someone else's loan is that it affects your ability to borrow in the future. When you become a guarantor for a loan of Rs 20 lakh or Rs 50 lakh, the bank counts the entire loan amount as your contingent liability. In such a situation, when in future you go to the bank to take a home loan, car loan or business loan for yourself, then while assessing your income, the bank will also add the EMI of that guaranteed loan to your existing liability. Because of this, either you will be approved for a loan amount that is much less than your requirement, or the bank may reject your application altogether.
As per RBI guidelines, if the principal borrower willfully does not repay the loan (willful defaulter) or becomes insolvent, the bank has full legal right to recover the outstanding loan directly from the guarantor. As per the clear rules of the Supreme Court and RBI, it is not necessary for the bank to first recover the property by selling the property of the main borrower and only then approach the guarantor. The bank can directly send legal notices to the guarantor, initiate recovery proceedings from his bank accounts and even take action to attach the movable and immovable property of the guarantor. Therefore, while becoming a guarantor, assuming that you will never have to pay the money can prove to be a big financial mistake.
If it becomes your compulsion to become a guarantor for a very close relative or family member, then take some basic precautions before signing the documents. First of all get clear information about the person's source of income, job stability and past credit history (CIBIL report) to ensure that he is capable of repaying the EMI. Secondly, check whether any property or gold is being pledged as collateral against the loan, as the risk on the guarantor is slightly lower in a secured loan as compared to an unsecured loan. Third, read every condition of the loan agreement carefully and never sign any blank or incomplete form. Fourth, ask the primary borrower to ensure that he takes a term insurance or loan protection cover along with the loan, so that in case of any untoward incident, the insurance company pays off the outstanding loan and the burden does not fall on the guarantor. Finally, once you become a guarantor, it is almost impossible to withdraw your guarantee mid-way, as it requires the written consent of both the bank and the principal borrower.