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Guaranteed Loan: Definition, How It Functions, and Examples

By Julia Kagan

Updated October 20, 2021

Written by Thomas J. Catalano

Facts checked by Skylar Clarine

What Is a Guaranteed Loan?

A secured loan is one type of loan that an outside party guarantees or takes over the debt obligation for–in the event that the borrower defaults. In some cases, a guaranteed loan is insured by a government agency, which will purchase the debt from the lending financial institution and assume liability in the loan.

Important Takeaways

A guarantee loan is a type of loan that an outside party is willing to pay the loan if the borrower should default.

A guaranteed loan is used by borrowers with bad credit or who have little in terms of financial resources. It enables financially unattractive candidates to get the loan and ensures that the lender will not lose funds.

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

Guaranteed mortgages are usually backed by either the Federal Housing Administration or the Department of Veterans Affairs. 12 federal student loans are backed 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 can be signed for borrowers who are not a suitable candidate for a regular bank loan. It is a way for those in need of financial assistance to secure money when they would not qualify to acquire these loans. The guarantee ensures an institution lending the money will not incur excessive risk in issuing these loans.

The types of Guaranteed Loans

There are a variety of guaranteed loans. Some are safe 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’re thinking about.

Guaranteed Mortgages

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

homebuyers that are considered to be risky borrowers–they’re not eligible for a conventional loan, for example, or they do not have enough down payment, and need to take out a loan that is close to the total amount of their home’s value–may get a guaranteed mortgage. FHA loans require that the borrower pay for mortgage insurance to protect the lender in case the borrower is in default on their home loan.1

Federal Student Loans

Another kind of secured loan is a federal student loan which is insured by an organization of the Federal Government. The federal student loans are among the easiest student loans to obtain because they require no credit test and they come with the most favorable terms and the lowest interest rates since they are guaranteed by the U.S. Department of Education provides them with taxpayer dollars.3

In order to apply for federal student loan you must fill out and submit the free Application for Federal Student Aid, or FAFSA every year you wish to be in the federal student aid program. The repayment period for these loans starts when the student leaves college or drops below half-time enrollment. Many loans also come with an grace period.3

Payday Loans

The third type of guaranteed loan is a payday loan. When someone takes out the payday loan, their paycheck serves as the third party that is responsible for the loan. The lending company gives the borrower the loan, and the borrower sends the lender a post-dated cheque that the lender then cashes on that date–typically two weeks after. Sometimes lenders will require access to an electronic account of the borrower in order to access funds, but it’s best not to take an unguaranteed loan in these circumstances particularly in the case of a lender that isn’t a traditional financial institution.

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

The issue in payday loans is that they tend to create the cycle of debt that can create additional issues for those already in tough financial straits. This could happen if a borrower doesn’t have the funds to pay off the loan when they reach the conclusion of their typical two-week timeframe. In this case the loan transforms into a different loan with a new set of charges. Interest rates can be as high as 400% or more–and lenders typically charge the highest rates that are permitted under local laws. Unscrupulous lenders might try to make a loan payment prior to the date the check was posted and risk the possibility of overdraft.4

Alternatives to payday guaranteed loans are personal loans that are accessible via local banks or online and credit card cash advances (you could save money when compared to payday loans even with rates for advances that are as high as 30 percent), as well borrowing funds from family member.

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