How being a loan guarantor can seriously impact your finances

A loan guarantor is someone who agrees to repay a borrower's debt if the borrower defaults on the loan. This role is often taken on by close friends or family members to help the borrower secure a loan that they might not otherwise qualify for due to insufficient credit history or income. However, this seemingly supportive act can have severe financial repercussions for the guarantor.

Financial Liability

When you sign on as a guarantor, you are essentially agreeing to take on the borrower's debt if they fail to repay it. This includes not only the principal amount but also any accrued interest and penalties. For instance, if a borrower takes a RM500,000 home loan with a 35-year repayment plan at a 4% annual interest rate and defaults after four years, the guarantor would be responsible for settling the outstanding balance of RM463,721. This could deplete your savings and severely impact your financial stability.

Impact on Credit Score

Your credit score is a critical factor in your financial health, influencing your ability to secure loans, credit cards, and even employment in some cases. If the borrower misses payments or defaults on the loan, and you are unable to cover the payments, your credit score will take a hit. This negative mark can stay on your credit report for years, making it more difficult for you to obtain credit in the future.

Risk of Bankruptcy

In extreme cases, if both the borrower and the guarantor are unable to repay the loan, the guarantor could be declared bankrupt. This is particularly true for non-social guarantors, meaning those who guarantee loans taken for business or other profit-making purposes. Bankruptcy can lead to the seizure of your assets, restrictions on your employment, and even travel bans.

Weighing the Risks Before Signing

Before agreeing to become a loan guarantor, it's crucial to thoroughly understand the financial risks and implications. Here are some steps you can take to protect yourself:

Read Every Word of the Contract: Many guarantors skim through contracts without fully understanding them. Make sure to read the agreement document word for word, paying close attention to clauses related to the loan amount, interest rate, and repayment terms.

Seek Legal Advice: If you are unsure about any legal terminology or implications, consult a lawyer. They can help you understand your rights and obligations as a guarantor.

Assess Your Financial Status: Consider whether you are financially capable of repaying the loan if the borrower defaults. This includes evaluating your current financial commitments and future financial needs.

Evaluate the Borrower's Financial Situation: Talk to the borrower about their financial stability and repayment plan. Ensure you are confident in their ability to repay the loan.

Potential Impact on Future Loan Eligibility

Being a guarantor can also affect your ability to secure loans for yourself in the future. Banks consider the debt-to-income ratio, which is the percentage of your gross monthly income used to repay debt, when assessing your loan eligibility. For example, if you are the guarantor for a RM500,000 home loan with a 4% interest rate and a 35-year tenure, the monthly instalment payment would be RM2,214. If your monthly salary is RM5,000, your debt-to-income ratio would be 88.6%, making it unlikely for you to secure another loan.

Steps to Avoid Financial Pitfalls

To avoid the financial pitfalls of being a loan guarantor, consider the following steps:

Understand the Borrower's Need for a Guarantor: Banks typically require a guarantor if the borrower has a poor credit history, low income, or insufficient credit history. Make sure you understand why the borrower needs a guarantor and assess the associated risks.

Monitor the Borrower's Repayment Habits: Keep track of the borrower's repayment habits to ensure they are making timely payments. This can help you avoid unexpected financial liabilities.

Consider Loan Protection Insurance: Encourage the borrower to opt for loan protection insurance to reduce your financial liability in case of their demise or disability.

While being a loan guarantor might seem like a noble act, it comes with significant financial risks. It's crucial to thoroughly understand these risks and take necessary precautions before agreeing to become a guarantor. Always seek legal advice, assess your financial stability, and evaluate the borrower's repayment capability to protect yourself from potential financial pitfalls. By understanding the hidden financial risks of being a loan guarantor, you can make an informed decision that safeguards your financial health and future.