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Guaranteed Loan Guaranteed Loan: Definition, How it Works, Examples
By Julia Kagan
Updated on October 20, 2021
Review by Thomas J. Catalano
Fact checked by Skylar Clarine
What is a guaranteed loan?
A guaranteed loan is a loan that is guaranteed by a third party, or assumes the obligation of the debt in the event that the borrower defaults. Sometimes, a guaranteed loan is insured by a government agency that will purchase the loan from the lending financial institution and take on responsibility for the loan.
Key Takeaways
A guaranteed loan is a type of loan in which an outside party agrees to pay if the borrower defaults.
A guaranteed loan is a loan that is guaranteed to borrowers with poor credit or little in the way of financial resources; it allows financially unattractive applicants to be eligible for an loan and guarantees that the lender won’t be able to recover the money.
Guaranteed mortgages, federal student loans as well as payday loans are all examples of secured loans.
Guaranteed mortgages are usually backed by the Federal Housing Administration or the Department of Veteran Affairs;12 federal student loans are guaranteed by the U.S. Department of Education; payday loans are guaranteed by the lender’s paycheck.3
How a Guaranteed Loan Functions
A secured loan agreement may be made when a borrower is an unattractive candidate for a standard bank loan. It’s a means for those in need of financial assistance to secure money when they would not qualify to acquire these loans. This guarantees that the lending institution does not incur excessive risk in issuing these loans.
The types of Guaranteed Loans
There are several guaranteed loans. Certain are secure and reliable ways to raise funds, while others carry risks that may include large interest charges. It is important to carefully read the terms of any guaranteed loan they’re considering.
Guaranteed Mortgages
A prime example of a guarantee loan is a guaranteed mortgage. The third party guaranteeing these home loans typically is the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA).12
Buyers who’re considered to be risky borrowers–they don’t qualify for a conventional mortgage for example, or they don’t have an adequate down payment and have to borrow up to 100% of the property’s value, may be eligible for a guaranteed mortgage. FHA loans require that the borrower pay for mortgage insurance in order to protect the lender in the event that the borrower is in default on their home loan.1
Federal Student Loans
Another type of secured loan is a federal student loan which is insured through an agency within the Federal government. Federal student loans are among the easiest student loans to qualify for–there is no credit test, for example–and they have the most favorable terms and the lowest interest rates because federal government agencies like the U.S. Department of Education assures them using taxpayer dollars.3
To be eligible for a federal student loan, you must complete and submit the free Application to Federal Student Aid, or FAFSA, each year that you want to remain eligible for federal student aid. The repayment period for these loans starts when the student has graduated from college or drops below half-time enrollment. Many loans also come with grace period.3
Payday Loans
The third type of secured loan is one called a payday loan. When a person takes out the payday loan, their paycheck plays the role of the third party who guarantees the loan. A lending organization provides the borrower with an loan and the borrower then writes to the lending institution a post-dated check which the lender cashes on that date–typically two weeks later. Sometimes, lenders will require electronic access to a borrower’s account to pull out funds, however, it’s recommended not to accept the guarantee of a loan under those circumstances particularly when the lender isn’t a traditional financial institution.
Payday guaranteed loans often ensnare borrowers in an endless cycle of debt that can have interest rates as high as 400% or more.4
The issue of payday loans is that they can create an unending cycle of debt which could cause further problems for people who are already struggling financially. This could happen if the borrower isn’t able to come up with the funds to pay off the loan at the end of the usual two-week term. In this scenario the loan is converted into a new loan that comes with a brand new set of fees. Interest rates can be up to 400% or more. In addition, lenders typically charge the highest interest rates that are permitted under local laws. Some lenders who are not careful may try to cash a borrower’s check before the post date this can lead to the risk of overdraft.4
Alternatives to payday-guaranteed loans are personal loans that are accessible at local banks and on the internet and credit card cash advances (you could save money over payday loans even with rates for advances that are as high as 30 percent) and borrowing money from family member.
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