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Guaranteed Loan: Definition, How It Functions, and Examples

By Julia Kagan

Updated on October 20, 2021

Reviewed by Thomas J. Catalano

The factual information is verified by Skylar Clarine

What is a guaranteed loan?

A guaranteed loan is a loan that a third party guarantees–or assumes the debt obligation for–in the case that the borrower fails to pay. Sometimes, a guarantee loan is insured by a government entity, which will purchase the debt from the lending financial institution and assume liability for the loan.

Important Takeaways

A secured loan is a form of loan where an outside party agrees to pay if the borrower defaults.

A secured loan can be used by those with poor credit or little in terms of financial resources; it enables financially unattractive candidates to get an loan and assures that the lender doesn’t lose funds.

Guaranteed mortgages, federal student loans as well as payday loans are all examples of secured loans.

The guarantee of mortgages is usually provided by either the Federal Housing Administration or the Department of Veterans Affairs. 12 federal student loans are insured through the U.S. Department of Education; payday loans are guaranteed by the borrower’s paycheck.3

How a Guaranteed Loan Functions

A guaranteed loan agreement may be made for borrowers who are not a suitable candidate for a regular bank loan. It’s a method to help those who require financial aid to obtain funds when they otherwise may not be eligible for these loans. This guarantees an institution lending the money will not have to take on excessive risk when making these loans.

The types of Guaranteed Loans

There are many secured loans. Certain are secure and reliable ways of raising money, but others involve risk that could include expensive interest costs. Borrowers should carefully scrutinize the terms of any guaranteed loan they are considering.

Guaranteed Mortgages

One example of a guaranteed loan is a mortgage with a guarantee. The third party guaranteeing these home loans typically is usually the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA).12

Buyers who’re considered risky borrowers–they aren’t eligible for a conventional loan, for instance, or don’t have an adequate down payment and have to borrow close to 100percent of the property’s value, may be eligible for a guaranteed mortgage. FHA loans will require borrowers pay mortgage insurance to safeguard the lender in the event that the borrower fails to pay their home loan.1

Federal Student Loans

Another type of guaranteed loan is a federal student loan, which is guaranteed through an agency within the Federal government. Federal student loans are the simplest student loans to get because there is no credit test and they come with the most favorable terms and lowest interest rates because federal government agencies like the U.S. Department of Education guarantees them with taxpayer dollars.3

To be eligible for a federal student loan you must fill out and submit the free Application of Federal Student Aid, or FAFSA, each year that you wish to be in the federal student aid program. The repayment of these loans starts when the student leaves college or drops below half-time enrollment. Many loans also have an grace period.3

Payday loans

The third type of guaranteed loan is one called a payday loan. If someone applies for a payday loan, their paycheck is the third party that guarantees the loan. The lending company offers the borrower an loan, and the borrower sends an dated check that the lender pays at the time of the date, usually two weeks after. Sometimes lenders will require access to an electronic borrower’s account to pull out funds, however it is best not to sign onto an unguaranteed loan under those circumstances, especially in the case of a lender that isn’t a bank that is traditional.

Guaranteed payday loans typically trap borrowers into an endless cycle of debt that can have interest rates of 400% or more.4

The problem in payday loans is that they can create an unending cycle of debt that can create additional issues for those already in tough financial straits. It can happen when the borrower isn’t able to come up with the money to pay back their loan after the usual two-week period. In this case the loan transforms into a different loan with a new round of fees. The interest rates could be as high as 400% or more. Lenders generally charge the highest rates that are permitted under local laws. Unscrupulous lenders might try to cash a check from a borrower prior to the date of posting and risk the possibility of overdraft.4

Alternatives to payday-guaranteed loans include unsecured personal loans available through local banks or on the internet and credit card cash advances (you can save a significant amount on payday loans even with rates for advances that are as high as 30%) and borrowing money from friend or relative.

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