What Is a Guaranteed Loan?
A guaranteed loan is a loan backed by a third party that will repay the loan if it is defaulted. The third party can be a person, a company, or a federal organization. Sometimes the government backs the loan and other times the borrower's paycheck serves as a guarantor.
But just because you can get a guaranteed loan doesn't mean it's always a good idea. By understanding the different types of guaranteed loans, you can better evaluate your options and decide if the terms are worth it.
Definition and examples of a Guaranteed Loan
A guaranteed loan means that a third party agrees to repay the loan if the borrower defaults. Secured loans allow high-risk borrowers to access the financing they need.
When a loan is guaranteed, lenders are more willing to work with borrowers who would not normally be considered good candidates for a loan.
For example, the federal government offers guaranteed mortgages to borrowers who might not otherwise be able to obtain 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 Veterans Affairs (VA), the Federal Housing Administration (FHA), and the US Department of Agriculture (USDA).
How does a Guaranteed Loan work?
Borrowers looking to buy a home may not always meet the credit or down payment criteria to qualify for a conventional mortgage. For example, their credit score may not be high enough or they may not be able to pay the 20% down payment.
The federal government offers secured mortgages to these types of borrowers. Borrowers will apply for a mortgage through a private lender and the VA or FHA will guarantee the loan. This enables borrowers to access the financing they need and 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 is easy to confuse guaranteed loans with secured loans, but they are not the same. Both types of loans are less risky for the lender, but the loans work in different ways.
A guaranteed loan is backed by a third party, and if the borrower defaults, the third party repays the loan. A secured loan is backed by an asset that is used as collateral, and the lender will confiscate the asset in the event of default. For example, if you take out a loan to buy a car, the vehicle will be used as collateral. If you default on the loan, your lender will impound 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:
Student loans
The federal student loan program is another example of a guaranteed loan. Borrowers begin by completing the Free Federal Student Aid Form (FAFSA) and the Department of Education endorses the loan. Federal student loans have no credit requirements and low interest rates.
Payday loans
Payday loans are typically small loans of $ 500 or less, with the balance due the next payday. You will use your next paycheck to secure the loan, and your lender will electronically debit your account on the agreed date. But wage loans can have annual percentage rates close to 400%, which is why they are prohibited in some states.
Federal Home Loan Programs
VA, FHA, and USDA offer several types of secured mortgages designed to make homeownership affordable. The USDA guarantee for single-family home mortgages, for example, covers 90% of the money the lender gives to the borrower.
SBA loans
The SBA offers guaranteed loans to help small businesses access the financing they need. A business applies for the loan through a bank or lender, and the SBA guarantees a certain percentage of the loan.
Enjoy Watching This Video About Loans
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