Government-backed loans are loans provided by the government for a particular organization or person with a sovereign guaranty by the government.
The sovereign guaranty means that the government would pay back the loans if that particular organization or person is unable to pay back the loan.
The organization can be a small business or a huge corporation or even a non-profit. A person can be a single person or a group of people and even some discriminated minorities.
There are multiple reasons why a Government would guarantee a loan. It can be because the market considers it too risky to lend to that organization or person.
The Government would also guarantee a loan for anything that markets are unwilling to do because they consider it too risky, but these can be considered strategically important plans for the nation.
So, when Government introduces itself as the official guarantee, the rate at which the organization or person borrows makes the plan financially viable.
For example, there are many laws and regulations in the Netherlands where the Government officially guarantees the mortgage loans of its people. This allows everyone to borrow 100% of the value of their houses. It also allows everyone to have homes.
The Government-backed loans are mostly used by developing countries to build a huge infrastructure project where it needs international financing and the international borrowers believe that the company borrowing to execute the project would not be able to pay back.
But, the government of that company considers that particular infrastructure product as strategic and so it is willing to guarantee the loan.
Main types of Government-backed Loans
Government-backed loans are basically subsidized loans with the government as the official guarantor of that loan to achieve a particular goal.
The government-backed loans can be divided into three main types depending upon for what purpose these loans are mostly used by the Government. The three main reasons are given in figure 1 below.
Figure 1: Three main reasons for Government backed loans
The three main reasons for a government-subsidized loan are mortgages for house buying, Infrastructure, and, finally for strategic goals and plans. All of these three reasons are explained in great detail below:
Government-backed loans for Mortgages
Mortgage loans are by far the widest types of loans that are subsidized by governments around the world.
The United States of America has a proper department managing the subsidized loans for housing. It is called the Federal housing authority. The mortgages are also by far the biggest segment of the loans subsidized by the U.S. Government.
There are multiple housing plans subsidized by the government with each covering a particular sector or area. For example, there are housing loans for veterans and minorities.
Even States have their own form of state-backed housing loans. For example, a subsidized loan scheme for first-time house buyers.
Housing is considered a public good in many countries and that is why loans for housing are subsidized in these countries.
Government-backed loans for Infrastructure
The government helps in subsidizing the loans for infrastructure project that it thinks are extremely important.
These can be for bridges, roads, or railways. The project the Government think would help the larger public.
As said before, government-backed or government-subsidized loans are used mainly by the governments of developing economies.
The developing economies do not have companies that have shown a track record where they can borrow on the international market without any help from their Government.
These companies are not big enough or have never executed big projects which can provide a track history to help international creditors assess the risk.
So, the Government intervenes to help the company borrow money by providing a sovereign-backed guarantee. These types of loans are almost always for state-owned enterprises.
Government backed loans for Strategic Projects
The government provides strategic project with sovereign guarantee. This is mostly done in the developed worlds.
These loans can also come in the form of grants. For example, the highway system which connects all of the states in the United States of America was developed during the cold war.
It was considered at that time that there was no single infrastructure linking the Whole United States and in the case of a Soviet Invasion, many States would be left alone to fend for themselves.
So, to move troops and arms the inter highway system was constructed. It was a huge infrastructure project that required at that time, about one trillion U.S. Dollars.
But, it was considered a strategic project, so the government of the United States through a mixture of complex sets of government-backed loans executed this project.
This is just one big example. The grants may also be given for many small projects and that is how it usually happens. A grant of a few million to a new startup to develop emerging technology.
Main advantages of Government backed loans
There is a multitude of advantages associated with Government-backed loans. The main advantages of a government-backed loan are as follows:
i) Allowing people of lower income to get loans for buying houses at competitive rates.
ii) Allowing government to execute projects that it considers strategically important.
Main disadvantages of Government Backed Loans
As there are many advantages, there are also many disadvantages associated with government-backed loans. The main disadvantages are given as follows:
i) The tax payers are on the hook if the company or person does not pay back the loans.
ii) A great financial cost is put on the government if the infrastructure project does not provide the associated or expected financial benefits.
The government backed loans allows for the subsidized loans to the needy people and strategic sector.
The government guarantee significantly lowers the borrowing costs associated with the project which also increases the financial viability of the project.