A loan guarantor promises that the loan will be paid. A guarantor is different from a co-signer because the guarantor is only liable if it can be shown that the individual has defaulted on the loan. Student loans can be incredibly risky for financial institutions because many times the student has little or no credit history, no permanent sources of income, and no property to use as collateral for the loan. Therefore, lenders usually want some source of a guarantee that they will not lose their money.
The federal government acts as a student loan guarantor for certain types of student loans. The most popular of these loans is the Stafford Student Loans. The Stafford loans do not require a credit check so lenders are giving money to individuals who would likely be classified as poor credit risks. In return for lenders assuming the risk of student borrowers, they are given subsidies by the federal government to cover loans that students default on as well as give lenders an incentive to participate.
Many state governments also provide guarantees for student loans. The benefits of having state guarantors for student loans may increase the attractiveness of federal loan options because now the lender has incentives from both the state and federal government. Depending on the state, you may be eligible to receive special loans from both your home state and the state that you are attending college in. For example, if you are a resident of the state of Connecticut and attend school in California, you could apply for a CHELSA loan as a resident of Connecticut and the Campus Door Loan that is only available to California students.
Private companies that offer student loans may require that you have your own guarantor to sign the loan with you such as a parent or other relative. This increases the chances that the loan company will receive its payments and will not lose the amount lent if the student defaults on the loan.
Many states have set up their own guarantor agencies for federal loans. A few of these agencies, like the Great Lakes Educational Loan Service, guarantees loans for the states of Wisconsin, Minnesota, Michigan and Ohio. These guarantor companies are often able to offer special terms like waiving certain fees because of subsidies from the government.
Pros and Cons of Federal Guarantees
The benefit to having the federal government pay subsidies to a number of loan companies is that it gives student borrowers more options when they have to choose which company to take out a loan from. However, others argue that the government would be better served not paying the subsidies to these loan companies and just offering the loans straight from the government.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."