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Guaranteed Loan: Definition, How It Works, Examples

By Julia Kagan

Updated October 20 and 2021.

Written by Thomas J. Catalano

Facts checked by Skylar Clarine

What Is a Guaranteed Loan?

A guaranteed loan is one type of loan that an outside party guarantees or takes over the obligation to repay in the event that the borrower defaults. In some cases, a guaranteed loan is backed by a government agency, that will purchase the loan from the lending financial institution and take on accountability in the loan.

Important Takeaways

A secured loan is a type of loan in which an outside party promises to pay in the event that the borrower defaults.

A guaranteed loan can be used by those with poor credit or little in terms of financial resources; it allows financially unattractive applicants to get the loan and ensures that the lender will not be able to recover the money.

Guaranteed mortgages and federal student loans and payday loans are all examples of guaranteed loans.

Guaranteed mortgages are typically backed with the Federal Housing Administration or the Department of Veteran Affairs.12 Federal student loans are guaranteed through the U.S. Department of Education; payday loans are guaranteed by the lender’s paycheck.3

The Way a Secured Loan works

A guarantee loan arrangement can be negotiated for borrowers who are an unattractive candidate for a standard bank loan. It’s a method for those in need of financial aid to obtain 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 a variety of guaranteed loans. Certain are secure and reliable ways to raise money, however, others come with risks that may include expensive interest costs. The borrower should be aware of the terms of any guaranteed loan they’re considering.

Guaranteed Mortgages

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

Homebuyers who are considered to be risky borrowers—they aren’t eligible for a conventional mortgage for instance, or do not have enough down payment, and need to take out a loan that is close to 100percent of the home’s value—may get a guaranteed mortgage. FHA loans are a requirement that borrowers pay mortgage insurance in order to protect the lender in the event that the borrower fails to pay their home loan.1

Federal Student Loans

Another kind of secured loan is one that is a federal student loan which is insured by an agency of the federal government. The federal student loans are the simplest student loans to get because there is no credit check 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

If you want to apply for federal student loan you must fill out and submit the Free Application for Federal Student Aid, or FAFSA every year you want to remain in the federal student aid program. The repayment of these loans begins after the student leaves college or is unable to maintain half-time enrollment. A lot of loans also have grace period.3

Payday Loans

The third kind of secured loan is a payday loan. When someone takes out the payday loan, their paycheck plays the role of the third party who guarantees the loan. The lending company gives the borrower an loan and the borrower writes an dated check that the lender then cashes at the time of the date, usually two weeks after. Sometimes, lenders need electronic access to the borrower’s account to pull out funds, however it is best not to accept an unguaranteed loan in such a situation particularly in the case of a lender that isn’t a bank that is traditional.

Payday guaranteed loans frequently trap borrowers in an endless cycle of debt that can have interest rates as high as 400 percent or more.4

The problem with payday loans is that they tend to create an unending cycle of debt that can create additional issues for people who are already facing financial difficulties. This could happen if a borrower doesn’t have the funds to pay off the loan after their typical two-week term. In this scenario the loan is converted into a new loan with a whole new set of fees. Interest rates can be as high as 400% or more. In addition, lenders generally charge the highest rates allowed under local laws. Some unscrupulous lenders may even attempt to make a loan payment prior to the date of posting, which creates the risk of overdraft.4

Alternatives to payday-guaranteed loans are personal loans available via local banks or online and credit card cash advances (you can save considerable money when compared to payday loans even with rates on advances as high as 30 percent), or borrowing from a friend or relative.

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