What is a guaranteed loan?

Government-backed home loans are available to low-credit borrowers

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Buying a home is a huge decision, both in terms of your personal goals and your finances. Most homebuyers must take out a mortgage to afford a home, but some mortgage lenders have strict credit and income requirements that make it impossible for certain buyers to qualify.

For those with poor credit looking to get a mortgage for their dream home, a guaranteed mortgage can be the difference between approval and denial. With these loans, a third party is responsible for at least some of the debt if the original borrower defaults, which reduces the risk for lenders.

Key insights

  • Guaranteed loans are a type of financing in which a third party promises to pay the lender some or all of the loan amount if the borrower defaults.
  • Some common types of guaranteed loans include government-backed mortgages and federal student loans.
  • Family members and friends can also provide a loan repayment guarantee. While these individuals are called “co-signers” on an auto or personal loan, they’re often called “guarantors” on a mortgage.
  • Since loan guarantees provide lenders with another source of repayment besides the borrower and any collateral, lenders may be willing to offer guaranteed loans to borrowers they would otherwise consider too risky.

Guaranteed loan definition

A guaranteed loan is financing in which a third party agrees to repay the debt obligation if the original borrower defaults. This third party can be an individual, a corporation or even the government.

Aside from guaranteed mortgages, other guaranteed loans include government-backed student loans and loans supported by the guarantee of an individual, such as a friend or family member of the borrower.

Guaranteed loans can help those with poor credit or limited financial resources obtain financing. The guarantee allows lenders to recover some or all of the loan funds if the borrower defaults, so lenders can make loans they would otherwise shy away from.

» MORE: Best mortgage lenders

Guaranteed mortgage vs. non-guaranteed mortgage

The primary difference between a guaranteed and non-guaranteed mortgage is that your lender has an additional repayment source with a guaranteed mortgage. Both types of mortgages are secured by real estate, and your home is at risk of foreclosure if you don’t pay as agreed.

With a non-guaranteed mortgage, there are two potential repayment sources: the borrower’s regular payments and the sale of the loan’s collateral, i.e., the home.

A loan guarantee provides the lender with a third source of repayment. This third source of repayment offsets some of the lender’s risk since the guarantor promises to repay some or all of the loan if the borrower defaults. As such, it allows riskier borrowers to receive better rates and terms on guaranteed mortgages than they could qualify for with conventional mortgages.

How does a guaranteed loan work?

No matter what type of guaranteed loan you get, the third-party guarantor agrees to repay some or all of your loan if you default.

Guaranteed loans are often used by borrowers who can’t qualify for a loan on their own or want to get better rates and terms than they could otherwise get. For instance, federal student loans have no income or credit score requirements. And people with bad credit may be able to get a government-guaranteed mortgage.

When evaluating your loan application, lenders consider your financial condition, credit, any collateral you can offer and the level of support any guarantors provide. Since a loan guarantee provides another source of repayment aside from your own cash and collateral, it may allow you to get the financing you would be unable to get independently.

If you don’t repay your loan as agreed, your lender may:

  • Seize the loan’s collateral
  • Sue you for the deficiency balance after the proceeds of the collateral’s sale are applied to your loan
  • Attempt to recover the loan balance from the guarantor
  • Pursue all of these actions

The lender’s options depend on your state’s laws and the guarantee’s structure. Some states limit the number of actions a lender can take against a borrower, and some guarantees limit the amount of funds that a lender can recover from the guarantor.

How does a government-guaranteed mortgage work?

Getting a government-guaranteed mortgage is pretty similar to securing a traditional mortgage. You just need to apply through a private mortgage lender that offers the type of government-guaranteed loan you want.

Each type of government-guaranteed loan has its own eligibility requirements. While these standards are usually more flexible than a conventional loan, you still must meet them to qualify.

With a government-guaranteed loan, the mortgage lender’s investment is protected by a third-party government agency or department. This means that even if the borrower stops making payments, the lender will get paid back at least a portion of its money.

Depending on the loan type, a government-guaranteed mortgage might have features like:

  • A low minimum down payment
  • A low interest rate
  • Subsidized closing costs

Types of guaranteed mortgages

Several government entities, including the U.S. Department of Agriculture (USDA), the Department of Veterans Affairs (VA) and the Federal Housing Administration (FHA), guarantee mortgages. Each sets its own requirements and underwriting standards.

FHA loans
FHA loans are popular among first-time homebuyers and those with low credit scores or limited funds for a down payment. They offer low down payment minimums and flexible credit requirements. However, for those who have good credit and can afford a down payment of at least 10%, a conventional mortgage may cost less over time than an FHA loan.

The down payment funds for an FHA loan cannot come from a source that needs to be repaid. However, a cash gift can be used as a down payment for an FHA loan, provided the gift is well-documented, verified in writing and signed for by the donor.

If you’re considering an FHA loan, the property you’re financing must be your primary residence. Kendall Meade, a financial planner with the online bank SoFi, explained that to qualify for an FHA loan, “you must move in within 60 days [of closing], an inspection must occur and [the home] must be appraised by an FHA-approved appraiser.”

There are many types of FHA loans you can get, including:

  • Standard 203(b) mortgages
  • Home Equity Conversion Mortgages (HECMs)
  • 203(k) home rehabilitation and repair loans
  • Manufactured home loans
  • Financing for energy-efficient home improvements

» MORE: Pros and cons of an FHA Loan

VA loans
VA loans are for military service members, veterans and eligible surviving spouses and can be used to buy, build, repair or adapt a home for personal occupancy. Other VA loan requirements, including credit score and income minimums, are set by lenders.

These loans don’t require a down payment and can be taken out multiple times throughout an eligible borrower’s life. They don’t require mortgage insurance and have limited closing costs .

» MORE: VA loan requirements

USDA loans
The USDA’s Section 502 Guaranteed Loan Program facilitates loans for low- and moderate-income households. These loans are only available for homes in eligible rural areas and can be used to purchase, build, rehabilitate, improve or relocate a primary residence.

A USDA loan can be a great option if you’ve found somewhere you’d like to live (as long as it fits the rural requirements) but can’t afford home prices in the area.

USDA loans come with up to 100% financing, meaning those who qualify aren’t required to make any down payment. There are no minimum credit score requirements set by the USDA, but most lenders require a score of at least 640. The USDA does require that applicants have a stable income with a debt-to-income ratio (DTI) of no more than 41%, including the new mortgage payment.

» MORE: USDA eligibility maps: what they are and how to use them

How to get a guaranteed mortgage

The steps you’ll take to get a guaranteed mortgage are very similar to the steps you’ll take for any other type of mortgage. The main difference is that you’ll need to find a lender that offers the specific type of mortgage you’re trying to get.

To get a guaranteed mortgage, you should:

  1. Search for a lender that offers the type of guaranteed mortgage you want (FHA loan, VA loan, etc.).
  2. Apply for preapproval online by submitting personal details (name, taxpayer identification number, etc.), providing income documents (tax returns, bank statements, pay stubs, etc.) and selecting the repayment term you want.
  3. Submit an offer on the property you’ve chosen.
  4. Formally apply for the mortgage with your lender and pay any required fees, such as appraisal fees.
  5. Upon final approval, pay closing costs and sign the loan documents.

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    Are guaranteed mortgages easier to get?

    Yes, it’s often easier to get a guaranteed mortgage than a conventional mortgage because a third party agrees to pay at least a portion of a guaranteed mortgage if the borrower doesn’t pay as agreed. A guarantee makes a mortgage less risky for the lender, enabling the lender to offer easier qualification requirements.

    Do guaranteed loans have PMI?

    Similar to conventional loans, which usually require private mortgage insurance (PMI) if you make a small down payment, some government-guaranteed loans also require mortgage insurance. For example, a mortgage insurance premium is required for FHA loans. However, you do not need to pay for mortgage insurance if you get a VA loan.

    What is a guarantor mortgage?

    A guarantor mortgage is a home loan in which a third party agrees to repay the mortgage if the borrower doesn’t pay as agreed, similar to a co-signer on an auto or personal loan. Guarantors are often used when borrowers can’t qualify for loans on their own due to poor credit or limited income.

    Mortgage guarantors don’t have any rights to your home; they simply agree to repay the loan if you don’t.

    Bottom line

    If you’re eligible, a guaranteed loan can be a life-changing opportunity to help you get into a home you might not otherwise qualify for on your own. These types of mortgages are typically guaranteed by federal agencies and offer low (or no) down payment requirements, favorable interest rates and flexible credit score requirements.

    Government-guaranteed mortgages aren’t for everyone, though. If you have enough savings to make a large down payment and your credit score is strong, you might pay less over time with a conventional mortgage. Whatever your circumstances might be, you should explore all your mortgage options and work with a reputable lender that offers loans suited to your borrower profile.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Consumer Financial Protection Bureau, " FHA loans ." Accessed April 20, 2023.
    2. Consumer Financial Protection Bureau, " What is mortgage insurance and how does it work? " Accessed April 20, 2023.
    3. Geraci Law Firm, " A Personal Guaranty Contract Can Help Lenders Recover Even After Foreclosure ." Accessed April 21, 2023.
    4. Thomson Reuters Practical Law, " One-Action Rule ." Accessed April 21, 2023.
    5. USDA Rural Development, “ Single Family Housing Guaranteed Loan Program .” Accessed April 21, 2023.
    6. USDA Rural Development, “ Single Family Home Loan Guarantees .” Accessed April 21, 2023.
    7. U.S. Department of Housing and Urban Development, " Common Questions from First-Time Homebuyers ." Accessed April 21, 2023.
    8. U.S. Department of Housing and Urban Development, “ Housing Handbooks .” Accessed April 20, 2023.
    9. U.S. Department of Housing and Urban Development, “ Let FHA Loans Help You .” Accessed April 20, 2023.
    10. U.S. Department of Housing and Urban Development, “ Maximum Mortgage Limits 2023 .” Accessed April 20, 2023.
    11. U.S. Department of Housing and Urban Development, " Single Family Mortgage Programs ." Accessed April 20, 2023.
    12. U.S. Department of Veterans Affairs, " Buying a home with a VA-backed loan ." Accessed April 20, 2023.
    13. U.S. Department of Veterans Affairs, “ VA Home Loans .” Accessed April 20, 2023.
    14. USDAloans.com, “ USDA Loan Income and Credit Eligibility .” Accessed April 28, 2023.
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