What is a guaranteed loan?

Buying a home is a huge decision, both in terms of personal goals and finances. Almost all homebuyers have to take out a mortgage in order to afford a home, but some mortgage lenders and programs have stricter credit and income requirements.

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

Guaranteed loan definition

A guaranteed loan is a mortgage that requires a third party to assume the debt obligation if the borrower defaults. This neutral third party can be an individual, a corporation or (most commonly) the government.

Guaranteed loans are designed for those with poor credit or limited financial resources who would otherwise be denied a mortgage from a typical lender. These loans are meant to help “risky” borrowers secure a home loan by making them more attractive to lenders since they have a way to recover the loaned funds if the borrower defaults.

How does a guaranteed loan work?

Getting a guaranteed loan is pretty similar to the process of securing a traditional mortgage: You apply through a private mortgage lender that offers the type of guaranteed loan you want. Each type of loan has its own eligibility requirements (e.g., credit score, income, down payment); although these standards may be more flexible than on a conventional loan, you still must meet them to qualify.

With a guaranteed loan, a mortgage lender’s investment is protected by a third party. This means that even if the borrower stops making payments, the lender will make back its money. A guaranteed loan might have features such as a lower down payment amount, lower interest rate or lower closing costs, depending on the type of loan.

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 or who need help making a down payment. They offer low down payments, low closing costs and flexible credit qualifications. For those who can afford a down payment of at least 10%, a traditional mortgage may cost less over time than an FHA loan.

FHA loans let you use cash gifts as down payments, but these gifts must be well documented, verified in writing and signed and dated by the donor.

There are a few types of FHA loans, including traditional FHA mortgages, home equity conversion mortgages (HECM), FHA 203(k) improvement loans and FHA Energy Efficient Mortgages.

• Requirements
  • 500-plus credit score
  • Down payment of at least 3.5% (10% in some cases)
  • Debt-to-income ratio of 43% or lower
• Highlights
  • No minimum income requirements
  • Loans available up to $970,800

FHA, VA and USDA loans are the three most common types of guaranteed loans.

VA loans

VA loans are for service members, veterans and eligible surviving spouses and can be used to buy, build, repair, retain or adapt a home for personal occupancy. These loans don’t require a down payment and can be used for multiple properties. They also don’t have a mortgage insurance requirement, and they come with limited closing costs.

With VA loans, most of the requirements, including credit score and income minimums, are set by lenders.

• Requirements
  • VA Certificate of Eligibility
  • Use home as primary residence
• Highlights
  • No down payment
  • No prepayment penalty

USDA loans

The USDA’s Section 502 Guaranteed Loan Program provides rural 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 dwelling.

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 — one of our reviewers from Florida was in this position and used a USDA loan to build their home.

USDA loans come with up to 100% financing, with a 90% guarantee to approved lenders. There are no credit requirements for these mortgages.

• Requirements
  • Meet income eligibility (maximum income of 115% of median household income)
  • Use home as primary residence
• Highlights
  • 30-year fixed-rate loans
  • No credit requirements

Bottom line

If you’re eligible, a guaranteed loan can be a life-changing opportunity to help you buy a home. These loans are typically guaranteed by federal agencies and offer small (or no) down payments, favorable interest rates and flexible credit score requirements.

Guaranteed loans aren’t for everyone, though. Make sure to explore all your mortgage options and work with a reputable lender that has loan options suited to your financial situation and needs.