Thinking of being a loan guarantor for your relative or friend? Why it could cost you heavily 

Acting as a loan guarantor can seem like a helpful gesture, but it can significantly impact your financial profile, credit score, and borrowing capacity. By agreeing to guarantee a loan, you take on full responsibility for repayment if the primary borrower defaults. Lenders treat the guaranteed amount as potential debt, which can reduce your ability to secure additional loans and increase your financial risk.

A guarantor is legally liable to repay the borrower’s debt if they fail to make repayments. This includes the principal, interest, and any penalties. Even missing a single EMI can trigger the guarantor’s obligation.

While technically anyone can become a guarantor, lenders prefer close family members who meet strict eligibility criteria. A guarantor must satisfy the same credit and financial requirements as the borrower, including proof of income, assets, and repayment capacity. Even if you aren’t making monthly payments, your financial profile is scrutinized carefully because your liability activates on default. All Know Your Customer (KYC) documentation and supporting records are mandatory.

Credit implications

“Being a loan guarantor increases your credit exposure and links your financial profile to the borrower’s repayment behavior,” says Shruti Agarwal, Co-Founder of Stashfin. “Delays or defaults can negatively impact your credit score, liability, and future loan eligibility. Unless it’s a very close family member or someone you fully trust, acting as a guarantor is generally not advisable.” Evaluating the borrower’s repayment capacity beforehand is critical.

Insurance and protection options

Loan protection insurance can shield guarantors from contingencies such as the death, disability, or critical illness of the primary borrower. Agarwal notes that insurance may reduce liability but cannot replace due diligence. Assessing the borrower’s financial stability remains the first line of defense.

Legal implications

While there are no tax penalties for being a guarantor, your credit report will reflect this exposure. If the borrower defaults, lenders can initiate recovery proceedings, and courts can compel you to liquidate assets to repay the debt. Under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, banks may attach and auction property in extreme cases.

Tax liability

CA Suresh Surana explained: "Merely acting as a loan guarantor does not give rise to any direct tax implications under the Income-tax Act, 1961. The role of a guarantor is contractual and does not itself result in any income, gain, or perquisite chargeable to tax."

Relevant considerations include:

No tax at the stage of providing guarantee
Standing as a guarantor does not involve asset transfer or income accrual. Therefore, no tax arises merely by furnishing a guarantee.

Potential liability on invocation of guarantee
If the borrower defaults, the guarantor may have to discharge the debt. Such payment is an obligation under the guarantee and is not deductible, unless incurred wholly for business purposes or where there is a direct business nexus with the borrower.

Subsequent recovery from the borrower
If the guarantor recovers the amount, it is not taxable, as it reimburses an earlier payment. If recovery is impossible, the loss is personal and non-deductible.

Gift tax implications
If the guarantor makes a gratuitous payment (e.g., for close relatives or friends without commercial nexus), no tax applies. The borrower may need to consider Section 56(2)(x) if the benefit is without consideration and falls under “income from other sources.”

Future loan eligibility

Being a guarantor reduces your future borrowing capacity, as banks consider the guaranteed amount a potential liability. Even without a default, this exposure can affect your ability to raise additional debt.

In short, while guaranteeing a loan can help a loved one, it carries serious financial, legal, and credit risks. Assess the borrower’s stability, consider insurance, and monitor the loan to minimize potential consequences.