What Is a Guaranteed Loan?

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. Similarly, people with poor credit may still be eligible for 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.

What happens if you don’t pay?

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

If that happens, the guarantor becomes legally responsible for repaying the remaining balance, and their credit and finances could be affected just like yours.

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 guarantors limit the amount of funds that a lender can recover from them.

Guaranteed vs. non-guaranteed mortgages

The primary difference between a guaranteed and a non-guaranteed mortgage is that a guaranteed mortgage provides an additional repayment source for your lender. 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, on the other hand, provides the lender with a third source of repayment — typically a government agency or a financial institution.

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 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 receive at least a portion of its money back.

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 with good credit and an ability to afford a down payment of at least 10%, a conventional mortgage may prove to be less costly over time than an FHA loan.

The down payment funds for an FHA loan cannot come from a source that requires repayment. 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 and you must meet certain qualifications. “You must move in within 60 days [of closing], an inspection must occur and [the home] must be appraised by an FHA-approved appraiser,” said Kendall Meade, a financial planner with the online bank SoFi.

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 available to military service members, veterans and eligible surviving spouses and can be used to purchase, 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.

USDA loans

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.

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.

USDA loans come with up to 100% financing, meaning those who qualify aren’t required to make any down payment. The USDA does not set a minimum credit score requirement, 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.

Pros and cons of guaranteed mortgages

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.

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.