The risks to a loan guarantor: what you’re responsible for & the impact on your family

Becoming a guarantor for someone’s loan is a significant financial commitment and carries various risks and responsibilities under Indian laws. Understanding these implications is crucial before agreeing to guarantee a loan. Here are key points to consider, including the risks involved, the possibility of withdrawing from the guarantee, and the impact on family members in case of the guarantor’s demise.

Risks of Becoming a Guarantor

1. Primary Liability: As a guarantor, you promise to repay the loan if the primary borrower defaults. According to the Indian Contract Act of 1872, the liability of the guarantor is co-extensive with that of the principal debtor unless otherwise agreed (Section 128). This means the creditor can demand repayment from the guarantor without exhausting remedies against the principal borrower.
2. Financial Burden: You will be required to pay the outstanding loan amount, including interest and any associated penalties. This can create a significant financial burden, especially if the loan amount is substantial.
3. Credit Score Impact: The debt burden can impact your credit score. This can affect your ability to obtain loans or other credit facilities in the future.
4. Legal Proceedings: If the borrower defaults, the lender may initiate legal proceedings against the guarantor. This can lead to stress, legal expenses, and potential asset seizures if the court rules in favor of the lender.

Withdrawing as a Guarantor

Once you have signed a guarantee, withdrawing from it is challenging. Here’s what you need to know:

1. Consent of the Lender: Withdrawal from the guarantee requires the consent of the lender. The lender may not agree to release you from the guarantee unless a suitable replacement guarantor is provided or other security arrangements are made.
2. Revocation of Continuing Guarantee: According to Section 130 of the Indian Contract Act, 1872, a continuing guarantee can be revoked by the guarantor for future transactions by giving notice to the creditor. However, this does not release the guarantor from liability for transactions already entered into before the notice of revocation.
3. Agreement Terms: The terms of the guarantee agreement will typically specify whether and how a guarantor can withdraw. Carefully reviewing these terms is essential before signing.

Liability Transfer on Expiry of Guarantor

Upon the death of a guarantor, several scenarios can arise concerning the liability:

1. Estate Liability: The liability of a deceased guarantor does not automatically transfer to family members. However, the guarantor’s estate (assets left behind) can be held liable to the extent of the guarantee. The lender can claim against the estate of the deceased guarantor to recover the outstanding loan amount.
2. Succession: If the guarantor’s assets are insufficient to cover the liability, the remaining family members are not personally liable unless they have explicitly assumed the guarantee obligations or are co-guarantors.
3. Legal Framework: Section 131 of the Indian Contract Act, 1872, states that a continuing guarantee is revoked in the event of the death of the guarantor for future transactions, unless there is an agreement to the contrary. However, the liability for past transactions (before the guarantor’s death) remains enforceable against the estate.

Precautions Before Becoming a Guarantor

1. Understand the Borrower’s Financial Situation: Ensure you have a clear understanding of the borrower’s financial health and their ability to repay the loan.
2. Review the Agreement Thoroughly: Carefully read and understand the terms and conditions of the guarantee agreement. Seek legal advice if necessary.
3. Limit Your Liability: If possible, negotiate terms that limit your liability to a specific amount or period.
4. Keep Records: Maintain detailed records of all communications and documents related to the guarantee. This can be useful if disputes arise.

Decline in Use of Guarantors

In recent years, there has been a noticeable decline in the use of guarantors, with a shift towards insurance products. Lenders and borrowers are increasingly opting for loan protection insurance policies, which cover the outstanding loan amount in case of default, thus reducing the reliance on personal guarantors.

Conclusion

Becoming a guarantor involves significant risks and responsibilities. You must fully understand the legal implications and potential financial burdens before committing. If the borrower doesn’t repay, the liability will pass to the guarantor. While withdrawing from a guarantee is difficult and often requires the lender’s consent, the liability typically remains with the guarantor’s estate upon their death and does not extend to family members unless otherwise agreed. Thoroughly reviewing the guarantee terms and understanding the borrower’s financial situation are critical steps in mitigating risks. By being fully informed and taking necessary precautions, you can make a more secure decision regarding becoming a guarantor.

The views and opinions expressed in this blog are those of the author. All content provided is for informational purposes only and should not be taken as professional advice.