what is a financial guarantee 
a financial guarantee is an agreement that guarantees a debt will be repaid to a lender by another party if the borrower defaults essentially a third party acting as a guarantor promises to assume responsibility for a debt should the borrower be unable to keep up on its payments to the creditor guarantees can also come in the form of a security deposit or collateral the types vary ranging from corporate guarantees to personal ones understanding financial guaranteessome financial agreements may require the use of a financial guarantee before they can be executed in many cases a guarantee is a legal contract that promises repayment of a debt to a lender this agreement takes place when a guarantor agrees to take on the financial responsibility if the original debtor defaults on their financial obligation or goes insolvent all three parties must sign the agreement in order for it to go into effect 1guarantees may take on the form of a security deposit common in the banking and lending industries this is a form of collateral provided by the debtor that can be liquidated if the debtor defaults 2 for instance a secured credit card requires the borrower usually someone with no credit history to put down a cash deposit for the amount of the credit line financial guarantees act just like insurance and are very important in the financial industry they allow certain financial transactions especially those that wouldn t normally take place to go through permitting for instance high risk borrowers to take out loans and other forms of credit in short they mitigate the risk associated with lending to high risk borrowers and extending credit during times of financial uncertainty guarantees are important because they make lending more affordable lenders can offer their borrowers better interest rates and can get a better credit rating in the market they also put investors at ease making them feel more comfortable because they know their investments and returns are safe 1special considerationsa financial guarantee doesn t always cover the entire liability for instance a guarantor may only guarantee the repayment of interest or principal but not both sometimes multiple companies sign on as a party to a financial guarantee in these cases each guarantor is usually responsible for only a pro rata portion of the issue in other cases however guarantors may be responsible for the other guarantors portions if they default on their responsibilities financial guarantees may cut down the risk of default in most cases but that doesn t mean they re fool proof we saw this during the fallout after the financial crisis of 2007 2008 most bonds are backed by a financial guarantee firm also referred to as a monoline insurer against default the global financial crisis hit financial guarantee firms particularly hard it left numerous financial guarantors with billions of dollars of obligations to repay on mortgage backed securities mbss that defaulted causing financial guarantee firms to have their credit ratings slashed types of financial guaranteesas noted above guarantees may come in the form of a contract or may require the debtor to put up some form of collateral in order to access credit this acts as an insurance policy which guarantees payment for both corporations and personal lending here are some of the most common types of both a financial guarantee in the corporate world is a non cancellable indemnity this is a bond backed by an insurer or other secure financial institution it gives investors a guarantee that principal and interest payments will be made many insurance companies specialize in financial guarantees and similar products used by debt issuers as a way of attracting investors as noted above the guarantee gives investors comfort that the investment will be repaid if the securities issuer can t fulfill the contractual obligation to make timely payments it also can result in a better credit rating due to the outside insurance which lowers the cost of financing for issuers a letter of intent loi is also a financial guarantee this is a commitment that states that one party will do business with another it clearly lays out the financial obligations of each party but may not necessarily be a binding agreement 3lois are commonly used in the shipping industry where the recipient s bank provides a guarantee that it will pay the shipping company once the goods are received lenders may require financial guarantees from certain borrowers before they can access credit for example lenders may require college students to get a guarantee from their parents or another party before they issue student loans other banks require a cash security deposit or form of collateral before they give out any credit 