Guarantor of loan: Types, benefits, disadvantages & meaning
3 min read
Feb 27, 2024
Guarantor of loans plays a crucial role in the financial landscape, bridging the gap for borrowers who might not qualify for a loan on their own. But who exactly is a guarantor of a loan, and what are the implications of becoming one? Understanding the dynamics of having a loan guarantor is important for you as a borrower and for those who may be asked to help anyone in the lending landscape.
Meaning of loan guarantor
A guarantor of a loan is an individual or entity who promises to repay your debt if you fail to do so. They essentially act as a safety net for the lender, assuring them that your loan will be repaid even if you, as the primary borrower, encounter financial difficulties and are unable to fulfil your obligations. If you are in default, the guarantor becomes legally obligated to repay the outstanding debt, including any interest or fees accrued.
Guarantors are commonly required for loans if you lack sufficient credit history, income, or collateral to qualify for the loan on your own. While the loan guarantor's meaning is widely recognised, it's essential to grasp its significance as well.
Importance of a loan guarantor
A guarantor of a loan can be essential for securing loans, especially for those with:
- Limited credit history: If you have a short or insufficient credit history, you may struggle to qualify for loans or receive favourable terms. A guarantor with a strong credit score can boost your application and secure better interest rates.
- Unstable income: If your income fluctuates or falls below the lender's requirements, a guarantor's stable income can provide reassurance about their ability to repay the loan.
- Large loan amounts: For high-value loans like mortgages or business loans, lenders might require a guarantor to mitigate the risk associated with lending a substantial sum.
Types of guarantors
Loan guarantors can be categorised into different types based on their role and liability:
1. Personal guarantor: This is the most common type, where an individual pledges their personal assets (like savings or property) to secure the loan. E.g., Axis Bank Personal Loans, small business loans, or loans taken out by individuals with limited credit history or income.
2. Corporate guarantor: A company or business entity can act as a guarantor, especially for business loans, using its assets to cover the outstanding debt in case of default.
3. Government guarantee: In some cases, government agencies might act as guarantors for specific loans, providing a secure repayment guarantee.
4. Collateral guarantor: Instead of providing a personal or corporate guarantee, some loans may require collateral as security. In such cases, the collateral serves as a guarantor for the loan, and if the borrower defaults, the lender can seize the collateral to recover the outstanding debt.
Benefits and disadvantages of guarantors
| Benefits of guarantors |
Disadvantages of guarantors |
| Increased loan approval: Having a guarantor can increase the likelihood of loan approval, especially for borrowers with limited credit history or income. |
Financial responsibility: Guarantors assume financial responsibility for the loan if the borrower defaults, potentially leading to financial strain or damage to their credit score. |
| Lower interest rates: Lenders may offer lower interest rates to borrowers with guarantors, as the presence of a guarantor reduces the lender's risk. |
Limited financial flexibility: Acting as a guarantor may limit the guarantor's ability to obtain credit or loans for themselves, as lenders consider the existing guarantee obligations. |
| Access to higher loan amounts: With a guarantor, borrowers may qualify for higher loan amounts than they would on their own, enabling them to finance larger purchases or investments. |
Relationship strain: Acting as a guarantor can strain relationships, especially if the borrower defaults on the loan, leading to resentment or tension between the parties involved. |
| Establish or rebuild credit: For borrowers with poor credit history, having a guarantor can help establish or rebuild credit by demonstrating responsible repayment behaviour. |
Legal liability: Guarantors are legally obligated to fulfil the loan obligation if the borrower defaults, potentially exposing them to legal action or debt collection efforts. |
| Flexibility in loan terms: Lenders may offer more flexible loan terms, such as longer repayment periods or lower monthly payments, when a guarantor is involved, making the loan more manageable for the borrower. |
Risk of default: If the borrower defaults on the loan, the guarantor's assets or credit may be at risk, leading to financial losses or damage to their financial reputation. |
Guarantors vs co-signers
| Guarantors |
Co-signers |
| Legal obligation: Guarantors are liable only if the borrower defaults. |
Joint liability: Co-signers share responsibility for repayment. |
| Risk assessment: Lenders evaluate both the borrower and the guarantor. |
Credit assessment: Co-signers' credit impacts loan approval. |
| Relationship dynamics: Generally less direct involvement. |
Relationship involvement: A closer relationship with the borrower. |
| Release options: Can be released under certain conditions. |
Limited release options: There are fewer options for release. |
Also Read: How can you get a Personal Loan online with 6 easy steps?
Conclusion
While guarantor loans offer opportunities for borrowers, they also entail risks for both parties involved, including potential strain on relationships and financial liabilities.
As we define a guarantor loan and its significant role in facilitating access to credit for many individuals and businesses, it's crucial to understand the potential risks and responsibilities involved before taking on this commitment. Carefully weigh the benefits and disadvantages, seek professional advice if needed, and always prioritise informed decision-making when acting as a guarantor.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
