Personal loans are unsecured and, therefore, don’t require you to pledge any of your assets as collateral. However, there are other eligibility requirements that you must meet before a lender approves your loan application. These requirements generally include a minimum age and income, nationality, job type, and your credit history.
If you fail to meet any of these requirements, the lender may ask you to get someone as a guarantor for your loan. Wondering why a bank asks for a guarantor? They do so when they are not sure about your ability to repay the loan that you are applying for. With a guarantor, lenders just increase their chances of getting the loan amount back.
Some Common Situations When Banks Ask for a Guarantor
A lender may ask for a guarantor when:
- You don’t meet any or all of the eligibility criteria.
- The loan amount is too big, in comparison to your income.
- The tenure is too long.
- Your credit score is not in good shape.
- Your job is unstable and requires you to work in different cities.
- You have an unstable income.
What’s the Role of a Guarantor?
When someone guarantees your loan, they become legally liable to repay the loan in the event you, as the original borrower, default. On the flip side, if you agree to guarantee someone’s loan, you become responsible for their debt if they fail to repay.
Does a Guarantor Affect Your Personal Loan Interest Rate?
Having a guarantor may not guarantee you a cheaper loan, but it definitely improves your chances of getting the loan approved. No matter who guarantees your loan, the lenders will still account for your income, age, job conditions, credit history, and other criteria to determine the interest rate on your loan.
Explore Personal Loan Rates
Know Your Risks Before You Guarantee a Personal Loan
Guaranteeing a personal loan for someone is a tricky business. When you guarantee a loan with the purpose of helping someone in need of funds, you hope that they will pay it back in time. You just sign the loan document as a guarantor and you forget about it. Everything goes on smoothly until one day when you receive a letter from the bank demanding loan repayment.
When that happens, there’s nothing you can do anything to change it. That’s why, it’s important that you understand all the risks associated with guaranteeing a personal loan before you sign the dotted line. After all, you are putting your own financial future at risk for someone else. Check out everything you need to know when you guarantee a personal loan.
What Happens When You Guarantee a Loan?
- You become legally responsible for the loan
- Unlimited guarantees could spell disaster for you
- You can’t borrow against your own assets
- Effect on your borrowing power
- Legal consequences
- Everything reflects in your credit report
When you guarantee a personal loan, chances are you trust the borrower and his/her ability to repay the loan. But the future is unpredictable. Things can go wrong. And when that happens, it will be your responsibility to repay the loan.
The scope of the guarantee is the first thing you should look for in the agreement. If the agreement says “unlimited guarantee”, you will be responsible for not just the original amount but also for any subsequent amount that the borrower might borrow at a later stage. For instance, you guaranteed a friend’s loan. A year later, your friend decides to borrow some more amount. In that case, you will be a guarantor for both the original amount and the additional amount.
If you have used any of your assets as a guarantee, you will not be able to use the same asset as collateral for your own loan.
Your ability to borrow for yourself in the future gets affected when you act as a personal loan guarantor. Lenders generally reduce your loan eligibility to the extent of the guarantee, since the liability falls on you if the original borrower doesn’t pay.
In case you can’t repay the loan, the lender has the right to take a legal action against you. Furthermore, if you pledged any of your asset as a collateral, the lender could even choose to seize it, if the agreement allows.
When you guarantee a loan, it reflects in your credit report. If the original borrower defaults on the loan, it could hurt your credit score. The score would go further down if you are also unable to repay the loan. Once your credit score goes down, you know the consequences. Poor score indicates that you are a high-risk customer, which means that lenders will not be willing to lend you the money.
Not Sure What to Do? Ask Yourself These Questions
- Can you afford to pay the loan amount?
- How sure are you about the borrower’s ability to repay the loan?
- How is the borrower planning to use the loan amount?
- Have you read all the terms and conditions of the agreement?
- Can you opt out from this agreement?
This is the first thing you need to ask yourself before you agree to act as a guarantor. If you can’t pay the loan amount in case of default by the original borrower, don’t guarantee it.
No matter how closely you know someone, if you are guaranteeing a loan for them, then make sure you are satisfied about their ability to repay the loan. Find out about the borrower’s other liabilities, source and stability of income, and credit history.
If your friend, who is asking you to act as a guarantor, loves gambling or investing in risky businesses, don’t guarantee the loan. Make sure he/she has a good reason for taking the loan.
This would include reading the fine print to know the consequences, if something goes wrong. Also, make sure to check if it’s a limited guarantee or an unlimited guarantee.
Guaranteeing a personal loan is a huge responsibility. What if some day you want to be relieved from this responsibility? Are you allowed to opt out? Make sure you know if the agreement allows you to quit your role as loan guarantor.