Secured loans are an important part of the mortgage market, and it’s easy to see why. Generally speaking, lenders prefer buyers to buy homes at a 20% discount, but many borrowers simply don’t have the money to hit that threshold with today’s prices.
For those borrowers who can’t earn 20%, guaranteed mortgages can help. Here’s what you should know.
What is a secured loan?
A secured loan is one in which a third party provides a guarantee or assumes debt obligations in the event of default by the borrower. Sometimes, secured loans are guaranteed by a government agency that purchases the debt from the lending financial institution and is responsible for the loan.
How Secured Mortgages Work
While lenders are looking for a down payment to protect themselves in the event of a default, they want something else: as much loan as possible.
Simply put, many borrowers don’t have the down payment they need to get a loan. According to the National Association of Realtors, the typical first-time buyer bought a home at a discount of just 6% in 2019, while repeat buyers dropped 16%, both below the ideal 20%.
In short, without secured mortgages, there would be far fewer home sales. As a result, lenders accept less money from borrowers with third-party guarantees. The most common sponsors are the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA), which support FHA loans and VA loans, respectively. The Department of Agriculture also offers USDA loan guarantees for eligible areas.
Difference: VA loan programs are generally considered “guarantees,” while FHA loan programs are more commonly considered “insurance.” However, from the perspective of borrowers and lenders, they each provide third-party assistance to help borrowers qualify for loans.
Despite the lower down payment, secured mortgages must meet underwriting standards set by lenders and third parties. Lenders often have additional requirements beyond those specified by the guarantor, a practice known as “tiering.” For example, the FHA requires a minimum credit score of 580 and borrowers only need to repay 3.5%, but some lenders set a minimum credit score of 620.
Types of Secured Loans
There are many types of secured loans. Some are safe and secure ways to raise money, but others involve risks, which may include unusually high interest rates. Borrowers should carefully review the terms of any secured loan they are considering.
An example of a secured loan is a secured mortgage. In most cases, the third party guaranteeing these home loans is the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA).
Homebuyers who are considered high-risk borrowers — for example, they don’t qualify for a traditional mortgage, or they don’t have enough down payment and need to borrow nearly 100 percent of the home’s value — can get guaranteed mortgages. FHA loans require the borrower to purchase mortgage insurance to protect the lender if the borrower defaults on their home loan.
Federal student loans
Another type of guaranteed loan is a federal student loan, guaranteed by a federal government agency. Federal student loans are the easiest student loans to qualify for — no credit check, for example — and they have the best terms and lowest interest rates because the U.S. Department of Education guarantees them with taxpayer dollars.
To apply for federal student loans, you must complete and submit the Free Application for Federal Student Aid (FAFSA) each year to ensure you are eligible for federal student aid. Repayment of these loans begins after the student graduates from college or falls below midterm enrollment. Many loans also have a grace period.