Do you know that loan settlement by borrowers can lower the Credit Score of the Guarantor?

Who is a loan Guarantor? 

A loan guarantor is someone who guarantees to repay the loan amount in case the primary applicant(s) is unable to do so. When someone applies for a loan that exceeds the maximum limit assigned to the applicant or when the lender is not confident of the applicant’s repayment capacity due to reasons like a low credit score, they seek a loan guarantor to mitigate risk. The guidelines around loan guarantor, however, may vary from bank to bank.

Note: Do not confuse a loan guarantor with a co-borrower. A co-borrower has an equal responsibility of making timely repayments and is usually from the borrower’s immediate family like a spouse, parent/child, sibling, etc. A loan guarantor is on the other hand responsible to make the repayments only when the primary applicants, including co-borrowers (if any), fail to repay. To know more, Ask Mr. Goyal

Eligibility Criteria to become a Loan Guarantor 

You can become a guarantor if you satisfy the eligibility criteria of the lender. Usually, a list is shared by the lender to the applicant that includes specific criteria on who can become a loan guarantor.

How can becoming a guarantor affect you adversely?

Before you accept being a loan guarantor, there are a few things that you should keep in mind to avoid hurting your credit score. These are:

1. Your credit score will get affected – negative or positive

Becoming a loan guarantor is beneficial for the primary applicant but for you, the guarantor, this comes at a price. Your credit score is checked and your credit history evaluated. This loan will be shown in your credit report and may affect your credit score adversely if timely payments are not made or if the loan is settled.

2. If the loan is settled, your credit score will go down 

If the primary applicant is unable to repay the debt in time, the bank will then turn to you and you will be legally required to cater to the repayment obligations. From this point, it can go in two directions.

If you are able to repay the loan, your credit score may not get adversely impacted.

However, if you do not have the funds to repay the loan and manage to get the debt settled with the lender, it will have a strong negative impact on your credit score. The loan will be shown as “settled”, which is likely to lower your creditworthiness.

3. On loan settlement, you (the guarantor) will find it difficult to get a loan 

Once the term “loan settlement” is mentioned in your credit report, lenders will hesitate in approving your loan application because you were not able to fulfill your previous responsibility as a loan guarantor. Usually, if lenders find anything alarming in a borrower’s credit history, they perceive it as a risk and generally, avoid sanctioning the loan.

So, should you Guarantee a loan or not?

Although when a bank or other financial institution approaches you to guarantee a loan, it simply says that you are creditworthy and you have a good credit score. But then, as we read above, if there is even a single late payment or an altogether loan settlement, it may lower your credit score by noticeable points.

You should be financially sound and confident to repay the loan on behalf of the borrower should there be a need.

It should be noted that the guarantor does not enjoy the benefits of the loan but is liable to repay the loan in case the borrower is unable to do so.  Therefore, if the loan is settled, or should we say, partly paid, it affects both the signees, i.e. the applicant and the guarantor.

Conclusion

Any financial decision requires that you think about it and its long term impact. Guaranteeing a loan is not different; so understand the full implications and responsibility of being a guarantor before you choose to become one. Do consider, you do not have control over how the borrower is going to behave through the entirety of the loan term.

Before becoming a loan guarantor, first ensure you have the repayment capacity, just in case, it’s needed. Also, since becoming a loan guarantor can adversely impact your credit score, do consider if you have any life-goals coming in the near future like buying a house or your child’s education wherein you may need to avail a loan. If you need to access credit in the short to medium term, it’s best to avoid becoming a loan guarantor, unless absolutely necessary, and instead, focus on building your own credit score.

However, if you have the capacity and can help a loved one in need, do go ahead.

Some frequently asked questions about loan settlement and its impact on one’s credit health:

What is a loan settlement?

If a borrower is unable to repay the loan due to some reasons, lenders sometimes offer a one-time settlement of the loan. This means that the lender will accept a lower repayment amount than the outstanding amount and close the loan.

Does a one-time loan settlement affect one’s credit score or multiple settlements?

A loan settlement, be it once or more, will affect your credit score negatively. Also, if your credit history shows a loan settled once, you might find it hard to get another loan to be approved, at least for the next few years after you settle the loan

For how long would the loan settlement show in my credit history?

A loan settlement will show in your credit history for several years. Therefore, do reconsider and evaluate other options before getting a loan settled.

Are loan settlement and loan closure the same things?

No. Loan closure is when you have paid your loan in full. It may impact your credit score positively since it shows strong repayment capacity. Loan settlement is when you are not able to pay your loan amount in full and get it settled for a lesser amount. Loan settlement adversely affects your credit score, i.e. by bringing it down.

Satpal Yadav is a content writer with a specialization in the field of personal finance. He writes to educate people and solve common queries related to government schemes and personal finance.

PS: We have no association with any Credit Rating agencies like CIBIL, Experian, Equifax, or CRIF High Mark – which are the only Credit Rating Agencies in India