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Financial guaranty insurance is a type of insurance taken out by lenders to cover themselves against a borrower failing to repay the loan. Companies offering financial guaranty insurance effectively act as a last line of defense. This means they must have a much better credit rating than the person or organization borrowing the money.
Technically the words guaranty and guarantee are interchangeable and are simply spelling variations. In practice, guaranty is generally used to refer to a legal obligation to cover a debt if it is not paid. This distinguishes it from other uses of guarantee, such as a guarantee that a physical product will work as advertised.
In theory, financial guaranty insurance can cover any type of loan. In practice, there are often barriers on it covering particular types of loan, most notably mortgages and consumer credit. These barriers vary around the world as well as on a state-by-state basis in the US.
The big difference with this type of insurance is that it is bought by the lender. This is different from many loan-related insurance policies which are bought by the borrower to cover themselves in case they are unable to pay. Generally a lender will get financial guaranty insurance to cover a potential situation where a borrower becomes insolvent and there will be little or no prospect of obtaining any assets to cover the losses.
Some forms of financial guaranty insurance cover more than simply whether or not a borrower will repay a loan. For example, the insurance could pay out if interest rates change in a way that means the lender makes less money than expected from a deal. These extra variables mean this type of insurance can be very complicated. For this reason, it is sometimes exempted from particular statutory regulations covering other types of insurance.
While some firms offer financial guaranty insurance as part of a range of products, other firms offer it as their only business. These firms are known as monoline bond insurers. As well as having more specific experience in the subject, such firms may have simplified claims procedures allowing for quicker payouts than those offered by general insurers.
People using the phrase “financial guaranty insurance” may be referring to the Financial Guaranty Insurance Company. This is a company specializing in insuring bonds. The company gathered a great deal of attention after financial problems in 2008 led to its credit rating being downgraded, making it much harder for the company to attract business.