Definition and Examples of a Guaranteed Loan
A guaranteed loan means a third party promises to repay the loan if the borrower defaults on it. Guaranteed loans make it possible for high-risk borrowers to access the funding they need.
When a loan is guaranteed, lenders are more willing to work with borrowers who usually wouldn’t be considered good candidates for a loan.
- Alternate definition: A loan that a third-party repays if you can’t.
- Alternate name: Guaranteed mortgage
For instance, the federal government offers guaranteed mortgages to borrowers who may otherwise not be able to get a home loan. Borrowers apply for a mortgage through a private lender, and the government backs the loan. These mortgages are typically backed by the Department of Veteran Affairs (VA), Federal Housing Administration (FHA), and the U.S. Department of Agriculture (USDA).
How Does a Guaranteed Loan Work?
Borrowers who would like to purchase a home may not always meet the credit or down-payment criteria to qualify for a conventional mortgage. For instance, their credit scores may not be high enough or they may not be able to pay the 20% down payment.
The federal government offers guaranteed mortgages to these types of borrowers. Borrowers will apply for a mortgage through a private lender, and either the VA or FHA will guarantee the loan. This allows borrowers to access the funding they need, and it protects the lender from the risk of default.
Guaranteed Loans vs. Secured Loans
|Guaranteed loan||Secured loan|
|Backed by a third party||Backed by an asset|
|If the borrower defaults, the third party repays the loan||If the borrower defaults, the lender seizes the asset|
It’s easy to confuse guaranteed loans with secured loans, but they aren’t the same thing. Both types of loans are less risky to the lender, but the loans operate in different ways.
A guaranteed loan is backed by a third party, and if the borrower defaults, the third party repays the loan. With a guaranteed loan, the borrower may be required to pay a utilization fee.
A secured loan is backed by an asset that is used as collateral, and the lender will seize the asset if you default. For instance, if you take out an auto loan, the vehicle is used as collateral. If you default on the loan, your lender will seize your vehicle.
Types of Guaranteed Loans
Mortgages are not the only type of guaranteed loan program available. Let’s look at three other examples of guaranteed loans:
The federal student loan program is another example of a guaranteed loan. Borrowers start by filling out the Free Application for Federal Student Aid (FAFSA), and the Department of Education backs the loan. Federal student loans don’t have any credit requirements and come with low interest rates.
Payday loans are typically small loans of $500 or less, and the balance is due on your next payday. You’ll use your upcoming paycheck to guarantee the loan, and your lender will electronically debit your account on the agreed-upon date. But payday loans can come with APRs that approach 400%, which is why they are banned in certain states.
Federal Home Loan Programs
The VA, FHA, and USDA offer various types of guaranteed mortgages designed to make homeownership affordable. The USDA guarantee for single-family-home mortgages, for example, covers 90% of the money the lender gives the borrower.
The SBA provides guaranteed loans to help small businesses access the funding they need. A business applies for the loan through a bank or lender, and the SBA guarantees a certain percentage of the loan.
- A guaranteed loan is backed by a third party, which can be an individual, company, or organization.
- Guaranteed loans give high-risk borrowers a way to access financing, and provide protection for the lender.
- A guaranteed loan is not the same thing as a secured loan.
- Secured loans are backed by an asset, while a guaranteed loan is backed by a third party.
- Mortgages, federal student loans, SBA loans, and payday loans are all examples of guaranteed loans.