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Saturday, January 9, 2016

Guarantor and Security for a Loan - What is the difference?

 
Guarantor and Security for Home Loan - what is the difference?

 

 

Guarantor

A guarantor is a person who makes a legally binding promise to either pay another person's debt or perform another person's duty if that person defaults or fails to perform it. The guarantor gives a "guaranty," that the debt or other obligation of the principal debtor will be fulfilled. A guarantor is demanded by many banks/HFCs to ensure the repayment of the loan advanced.

A contract of guaranty is a trilateral contract, that is, among three persons - the surety, the principal debtor and the creditor. Simply put, a guarantor is someone who is 'liable to pay' in case the original home loan borrower (i.e. the 'guaranteed') makes a default on his home loan repayments. In such a scenario, the HFC/bank will ask the guarantor to pay amount equal to the default. Guarantor, therefore, needs to be sure about the credibility of the borrower before agreeing to become his/her guarantor.

By taking a guarantor, the HFC/bank also puts a sort of a moral obligation on the borrower to repay the loan. Some of the circumstances when a guarantor is insisted are as follows:

  • In the case of a sole applicant, to avoid the risk of default in case something goes wrong with the applicant,
  • If the applicant's job is of transferable nature,
  • If the applicant is residing in a city different from the city where he intends to purchase the property,
  • If applicant is working in certain industries, typically software industry, where likelihood of the applicant going abroad either on assignments or to seek a permanent job is high
  • Lack of professional qualification such as in a self-employed case

Eligibility of the Guarantor:

A guarantor should satisfy all the norms relating to age and income of a normal borrower because the guarantor is equally liable to pay the loan in case the borrower defaults in repayment. Some HFIs may allow blood relative to stand as a guarantor while others may not.

Liability of the Guarantor:

The liability of a guarantor or surety towards the creditor cannot exceed the terms specified in the contract of guarantee. The liability of the surety towards the creditor is co-extensive with that of the principal debtor, unless it is otherwise provided in the contract of guarantee. In the case of a loan, if a guarantor binds himself to a maximum limit of the principal debt, his liability towards the creditor would be up to the principal amount of the debt. A guarantor, in common law, is in no better footing than the principal debtor. It is open to the creditor to proceed legally against the guarantor first for remedy.

Rights of the Guarantor:

A guarantor has a right to be informed about any change in the status of the borrower or any material change in the terms & conditions of the loan guaranteed. A guarantor also enjoys following other rights against the creditor.

  • A guarantor can ask the creditor to call upon the Principal Debtor along with him/her to pay off the due debt.
  • He/she can make available facilities of set off (if any) before payment to the creditor, when sued.
  • By paying off the debt, a guarantor is entitled to be subrogated to all the rights of creditor against Principal debtor including access to securities.
  • A guarantor can also pay off the due debt to the creditor voluntarily.

Security

In case of a loan, security is an asset that protects a Lender's risk until the loan is fully repaid. The main security for a home loan is the first mortgage of the property to be financed, normally by way of deposit of the title deeds and/or such other collateral security as may be necessary. The documents of the title are kept in the safe custody of the lender bank/HFC until repayment of the loan.

Primary Security

Primary Security is the asset created out of the credit facility extended to the borrower and/or which are directly associated with the project of the borrower for which the credit facility has been extended.

Collateral Security

Collateral security is any other security offered for the said loan, for example, lien over life insurance policy, fixed deposit receipts etc. The term collateral security denotes a separate obligation attached to another contract to guaranty its performance. It also means the transfer of property or of other contracts to insure the performance of a principal agreement. The property or securities thus conveyed are called collateral securities. The term can also be defined as extra security provided by a borrower to back up his/her undertaking to repay the loan.

Valuation of Security

Valuation of security, i.e. the property which is offered as security against the loan is required to be assessed. Valuation of the property can be done based on assessment of the quality of construction and keeping in view the prevailing rates in the neighborhood. Enquiries can also be made from the property dealers in the area. For more accuracy, help can be taken from a professional valuer. The valuers give valuation report based on land rate in the area, construction rate in the year of construction, type of construction, open area, covered area, furnishings provided and current market rate; generally after visit to property under consideration. Some Lenders may not require formal valuation, subject to certain conditions.

Difference between Guarantor and Security

Although both the guarantor and security against a loan serve the same purpose of ensuring repayment of the loan advanced, a guarantor can only be an individual who is ready to take the responsibility of loan repayment in the event of the default by the borrower, whereas a security can be any valuable thing representing the ownership of the borrower. The security is an asset against which you apply for loan and ensure your bank/HFC for the repayment of the loan.

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