The most important part of advancing loans to borrowers is that lenders protect themselves from the risk of losing their money. This risk is codified in certain actions that the borrower may take, such as failing to repay the loan at all, or repaying the loan only partially. If the lender allows borrowers to default with no obligation, the lender will soon have no money with which to lend to anyone.
Therefore, the lender has to take steps to protect themselves from irresponsible borrowers in order to make sure it can continue to lend to responsible borrowers. The alleviation of risk is the lender’s primary objective.
When it comes to mortgage loans, there are several ways that lenders can protect themselves. They can require borrowers to pay an additional premium for mortgage insurance. Mortgage insurance is not insurance for the borrower against the lender, but insurance for the lender against the borrower. If the borrower defaults, which means they fail to fulfill the terms of the loan contract, the lender is compensated by the payouts of the insurance policy.
Lenders can also require borrowers to have someone co-sign for the loan with them. This provides added pressure on the borrower not to default; not only is the co-signer just as responsible for the loan as the borrower, but the co-signer actually has a legal right to the borrower’s property if the borrower defaults. Ergo, it is in the borrower’s best interests to make the payments.
Sometimes, neither of these options are feasible due to the particular circumstances of the borrower. In these cases, lenders require someone to guarantee the mortgage. The guarantor on mortgage is responsible for making the payments if the borrower defaults. In other words, the guarantor takes on the risk of the borrower defaulting for the lender, making it easier for the lender to consider advancing money to the borrower.
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