Guaranteed Loan

Updated on March 19, 2024
Article byGayatri Ailani
Edited byGayatri Ailani
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Guaranteed Loan?

A guaranteed loan refers to a loan offered only in the presence of formal assurance from a third party to fulfill the debt obligations in case of default. The main parties involved in this type of loan are the lender, the borrower, and the third party.

Guaranteed Loan

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This type enhances credit availability and helps many small entities obtain financial assistance. For example, federal loan guarantees like FSA guaranteed loan provisions can reduce the large banks’ perceived risk of lending to informationally opaque firms. Another example is the Business and Industry (B&I) Guaranteed Loan Program of the U.S. Department of Agriculture, which guarantees loans to rural businesses by rural banks.

Key Takeaways

  • A guaranteed loan refers to the loan offered if a third party stands to guarantee the loan. It helps people with poor credit scores or financial health to get a loan.
  • The third party is liable to meet the borrower’s obligation fully or partially to the lender if the borrower defaults.
  • It differs from secured loans since collateral backs the secured loans instead of a third party. 
  • Federal student loans and guaranteed mortgages are famous categories. An example is the Single Family Housing Guaranteed Loan Program by USDA Rural Development. This program helps low- and moderate-income households in rural areas to own homes.

Guaranteed Loan Explained

A guaranteed loan is a type of loan under which a party other than the borrower promises to repay the lender fully or partially if the borrower fails to repay the loan. Generally, it occurs in the case of a borrower who is not eligible for the conventional loan directly due to poor credit scores, lack of financial health, or the students who plan to take a loan for higher studies. Furthermore, they are also guaranteed loans for bad credit.

A third party stands as a guarantee for the borrower. For the lender, it reduces the risk associated with failure in obtaining the repayment from the borrower. The third party is responsible for repaying the loan to the lender when the borrower defaults on making the payment. It is a hedging tool for lenders who might be skeptical before granting the funds. The availability of a guarantor makes guaranteed personal loans or other loans a common event.

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Types

There are several types of guarantees that are mentioned below :

  • Federal Student Loans: Guarantees are popular in the student loan market, with the federal government guaranteeing loans to people who are typically young and have no credit history. This guarantee encourages banks to lend to students. Federal student loans are the one federal government insures. Federal student loans are the easiest way to procure a loan because there is no credit check or stringent credit requirements, and it comes with a low-interest rate. In other words, it is a guaranteed loan approval with no credit check. Borrowers can take a loan by completing the Free Application for Federal Student Aid (FAFSA).
  • Payday Loans: In the case of payday loans, the borrower’s upcoming paycheck replaces the guarantor. Payday loans are often small sums of money but attract a high-interest rate. The loan is guaranteed on the next month’s paycheck, and the lender electronically debits the borrower’s account or obtains the amount on the agreed-upon date. The issue with these loans is that the potential of falling into a debt spiral is high if default happens.
  • Guaranteed Mortgages: Mortgage lenders obtain mortgage guarantees to get protection from borrowers’ payment failures. One example is the FHA loan. Federal Housing Administration (FHA) loans are loans from private lenders governed and guaranteed by this government organization. As a result, FHA loans often have lower credit scores and down payment requirements, making them simpler, and people can easily qualify for them compared to conventional loans.

Examples

Let us understand the concept with the help of examples:

Example #1

John, who has recently started working in a private firm, takes a home mortgage from a bank to buy a house. Although John will be liable to make loan payments, there is a requirement for a personal guarantee on loan. Mr.Marx, John’s father, takes the guarantee to repay the debt if John fails to make the loan payment with interest on the loan.

Example #2

By establishing lending requirements and lowering lender risk, the U.S. Small Business Administration assists small firms in obtaining capital. These SBA-backed loans are making it simpler for small firms to obtain the necessary capital. Rates and charges on SBA-guaranteed loans are often equivalent to those on non-guaranteed loans. The advantages of this type of financing include lower down payments, flexible overhead criteria, and no collateral requirements in certain cases. When it comes to businesses and households recovering from a declared catastrophe, SBA offers direct loans; In other cases, SBA facilitates this service through lending partners.

The most popular lending option, 7(a) loans, offers to fund companies with unique needs. This kind caps interest rates, limits costs, and guarantees a percentage of the whole amount. On the other hand, “504 loans” are long-term, fixed-rate funding sources for acquiring or repairing property, machinery, or other assets. Finally, the smallest lending program is a microloan, which offers $50,000 or less to aid start-ups.

Guaranteed Loans vs Secured Loans

Guaranteed loans are loans that the third party guarantees in case of default from the borrower’s end, whereas the collateral assets back secured loans in case of default. Generally, no third party is involved in the case of secured loans.

Frequently Asked Questions (FAQs)

What is an SBA guaranteed loan?

U.S. Small Business Administration created it to assist small businesses in obtaining capital. SBA offers the lender sufficient security to back the loan to small businesses. In addition, the lender may reclaim the loan’s guaranteed part from the SBA if the borrower defaults on the loan.

What is USDA guaranteed loan?

The Guaranteed Loan Program for USDA Rural Development helps approved lenders finance up to 100% of qualified borrowers’ house purchases in eligible rural areas.

What is the purpose of guaranteeing a loan?

If a lender decides they don’t want to lend money to someone on their own, they have the power to ask for a guarantee. The guarantor, or institution that provides the guarantee, is accountable if the borrower cannot repay the loan in full.

This article has been a guide to What is Guaranteed Loan and its meaning. Here, we explain its types with examples and comparisons with secured loans. You can learn more from the following articles –

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