Question

Explain how loan guarantee increases capital availability for small business. List and explain 3 types of loan guarantees. List and explain 3 advantages and 3 disadvantages of loan guarantee programs.

Answer 1

Various small businesses mention that one of biggest hurdles in the development of their businesses is lack of long term capital availability. In fact, the responses from financial institutions are often disheartening and hurtful to the growth of these firms. In this scenario comes the role of Loan Guarantee. This is normally undertaken by a third party that takes up debt obligation in the event of default. The Loan Guarantee idea helps the otherwise unqualified firms/ individuals to procure funds through a reliable third interference such as government for example.
The three types of loan guarantee includes
1) Guarantee loans for Mortgages: This type of guarantee loan is help financed by the federal government to risky households borrowers who would otherwise find it extremely difficult loans from any financial institutions.
2) Guarantee loan for students: Again the third party is generally the government which helps the students be given loans without credit checks, reasonable terms and low interests.
3) Payday loans: This is actually the type of guarantee loan where on the basis and existence of an individual's income, the debt obligation is given and the person becomes a qualified borrower. Here, the third party guaranteeing the loan is person's income.

3 advantages of loan guarantee programs
1) It helps in increasing the flow of investment and capital availability than would have been restricted without the loan guarantee.
2) It seems to give incentives to underestimated small enterprises that could not have reached their potential without guaranteed loans.
3) Last but not the least, it helps maintain a positive and more forth coming environment and helps the domestic economy to grow.

3 disadvantages of loan guarantee programs
1) Many individual small businesses are need to set up a proper organisation for its business to show a bigger picture. It results in wastage of time and energy.
2) it lead in incurring huge transactions costs
3) It just diverts the risk and in case of defaults, the debt of the third party in many cases government, the debt increases.