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Guaranteed Loan: Definition, How It Works, Examples

By Julia Kagan

Updated October 20 and 2021.

Reviewed by Thomas J. Catalano

Fact checked by Skylar Clarine

What Is a Guaranteed Loan?

A secured loan is a loan that a third party guarantees–or assumes the obligation to repay in the event that the borrower defaults. Sometimes, a guaranteed loan is backed by a government entity, who will buy the debt from the lending financial institution and assume responsibility in the loan.

The most important takeaways

A secured loan is a type of loan where 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 the way of financial resources; it enables financially unattractive candidates to qualify for the loan and ensures that the lender doesn’t be able to recover the funds.

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

Guaranteed mortgages are usually backed by either the Federal Housing Administration or the Department of Veteran Affairs.12 Federal student loans are backed by the U.S. Department of Education; payday loans are guaranteed by the person who is borrowing the paycheck.3

The Way a Secured Loan works

A secured loan agreement may be made in the event that a borrower is an unattractive applicant for a standard bank loan. It’s a method to help those who require financial assistance to secure money when they would not qualify to acquire these loans. And the guarantee means an institution lending the money does not incur excessive risk in the issuance of these loans.

The types of Guaranteed Loans

There are several secured loans. Certain are secure and reliable methods of raising money, but others involve risks that may include high interest rates. The borrower should be aware of the terms of any guarantee loan they’re considering.

Guaranteed Mortgages

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

Homebuyers who are considered risky borrowers–they aren’t eligible for a conventional loan, for example, or they do not have a sufficient down payment and have to take out a loan that is close to 100% of the home’s value–may get a guaranteed mortgage. FHA loans are a requirement that the borrower pay for mortgage insurance in order to protect the lender in case the borrower defaults on their home loan.1

Federal Student Loans

Another kind of secured loan is one that is a federal student loan which is insured through an agency within the Federal government. Federal student loans are the simplest student loans to qualify for–there is no credit verification, for example–and they have the most favorable terms and the low interest rates due to the fact that federal government agencies like the U.S. Department of Education guarantees them with taxpayer dollars.3

To be eligible for a federal student loan, you must complete 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 begins after the student graduates from college or is unable to maintain half-time enrollment. Many loans also come with grace period.3

Payday Loans

The third type of guaranteed loan is one called a payday loan. When someone takes out the payday loan, their paycheck is the third party that guarantees the loan. A lending organization provides the borrower with a loan and the borrower sends to the lending institution a post-dated check that the lender pays at the time of the date, usually two weeks after. Sometimes, lenders need electronic access to the account of the borrower in order to access funds, however, it’s recommended not to sign onto an unguaranteed loan under those circumstances particularly when the lender isn’t a bank that is traditional.

Payday guaranteed loans often ensnare borrowers in the cycle of debt, with rates of interest that can reach 400 percent or more.4

The issue of payday loans is that they tend to lead to the cycle of debt that can create additional issues for people who are already struggling financially. This could happen if a borrower doesn’t have the funds to repay his loan when they reach the conclusion of the usual two-week term. In this scenario, the loan is converted into a new loan with a new round of fees. The interest rates could be up to 400% or more–and lenders typically charge the highest rates that are permitted under local laws. Some unscrupulous lenders may even try to make a loan payment prior to the date the check was posted, which creates the risk of overdraft.4

Alternatives to payday-guaranteed loans include 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 of up to 30%), as well borrowing funds from friend or relative.