Guarantees can help a private lender reduce the risk of taking on debt by providing an extra layer of protection if a borrower fails or the value of the collateral drops. Full-recourse guarantees that lenders will be paid in full are the most popular in the mortgage sector and can make lending practically risk-free. However, there are other major types of guarantees which are discussed briefly below:
- Limited Guaranty: A limited guaranty is a simple payment guarantee that places a cap on how much a guarantor is responsible for, either a set money amount or a percentage of the total debt.
- Burn-Off Guaranty: A burn-off guaranty works similarly as a percentage-limited guarantee. It’s set up so that responsibility decreases over time and as agreed-upon standards are completed. This assurance can help both the lender and the guarantor reduce risk throughout the loan’s lifecycle.
- Joint Guaranty: Lenders have a few alternatives for risk distribution when many guarantors are involved in a loan transaction. With a Joint Guaranty, each guarantor is accountable for the entire amount. The lender gains since they only need to engage with one guarantor to get their money back in full, and the guarantors can work out the details themselves.
- Specific Performance Guaranty: The performance guarantee is based on certain circumstances or milestones rather than a payment. This is typical in contracts involving commercial real estate development or requiring particular behaviors.
- Carve-Out Guaranty: Liability is linked to bad activities, such as fraud or recourse events under the carve-out guarantee. If a borrower or guarantor commits particular bad acts or loss events, they are responsible for the damages or the entire loan amount in some situations. This allows lenders to reclaim cash while the judicial procedure plays out quickly.
To learn more about guarantees and how to use them to limit your risks as a lender, click here.
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