A loan guaranty is a commitment by a third party, or guarantee agency, to repay a loan in the event of loan default by the original borrower. Guarantee agencies are usually lending institutions or government agencies that insure loans against default and normally collect a small guarantee fee for each loan disbursement.
As an example, the Federal government’s Small Business Administration (SBA) provides loan guarantees of up to $1 million or 75% of the total loan amount, whichever is less. For loans that are less than $150,000, the SBA maximum guaranty is 85% of the total, whereas for less that $100,000, the guaranty tops out at 80%. SBA policy prohibits lenders from charging common fees associated with commercial loans. Nevertheless, there is a one-time guarantee fee, which the SBA charges the lender and is passed on to the borrower.
Similarly, Federal student loans are guaranteed against default by the Federal government, which enables them to be extremely low risk as compared to other types of unsecured loans. Student loan guaranty agencies charge the student a 1% fee for each disbursement to cover the costs of insuring the loan. If the student defaults, dies or is permanently disabled, the guaranty agency will reimburse the lender for the remaining balance on the loan.
The Federal government’s Department of Veterans Affairs (VA) also has a loan guaranty program for retired veterans of the armed forces, enabling them to borrow money to purchase homes. This program was started at the end of World War II and continues to this day.
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