A loan guarantee is a pledge by one party to become liable for a debt obligation if a borrower defaults. The guaranteeing party is called the guarantor.
The guarantor might be liable for just a portion of the debt (limited guarantee) or all of it (unlimited).
Young borrowers who do not have enough for a large deposit when buying a house and need a 100% mortgage (borrow 100% of the property value) commonly have a guarantor, who is usually a parent or relative. This person provides a guarantee to the lender to pay for any shortfall in the event of default.
Young people with no credit history often ask a relative with a good credit rating to guarantee their loan.
Sometimes the guarantor might be the government or a government agency.
While most borrowers who require a guarantor to get a loan tend to be either young individuals or non-established businesses, sometimes the borrower could be a major corporation. In 1979, American car giant Chrysler Corporation obtained a loan guarantee when it nearly collapsed.
Loan guarantees in the US
In the United States, there are several government-sponsored loan guarantee schemes. For example the Department of Veterans Affairs (VA) offers a VA loan service which guarantees mortgages. It was designed to offer long-term financing for American veterans (ex-servicemen and servicewomen) and their surviving spouses.
The US Small Business Administration, a government agency, has several federally-sponsored loan guarantee schemes, such as its 7(a) Loan Program, Disaster Loans, Microloan Program, and several more.
Other agencies that guarantee loans include Fannie Mae, the Federal Family Education Loan Program, Freddie Mac, the Government national Mortgage Association, and USDOE.
Loan guarantees in the UK
In the United Kingdom, the Enterprise Finance Guarantee (EFG), a government-guaranteed lending scheme, facilitates lending to viable companies that have been refused a loan or other form of debt finance due to inadequate security or a proven track record.
In such cases, EFG says it might be able to turn that refusal into an acceptance by offering a guarantee. However, the agency stresses “That is a decision for the lender and will only be considered if the lender is satisfied that your business is viable and can afford the loan repayments.”
“(A loan guarantee scheme is) a facility whereby banks are able to lend to firms that would not otherwise qualify for bank finance due to lack of track record.”
Video – Enterprise Finance & Business Funding
Peter Ibbetson, RBS small business chairman, explains how to secure a loan under the EFG loan guarantee scheme.