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The government offers loan programs through different departments that support individuals, communities and businesses according to their varied and unique needs. These loans provide capital for enterprises deemed worthy by the government that might not qualify for a loan on the open market. Government loan programs aim for the following long-term benefits at the social and economic levels:
- To improve the overall national economy as well as quality of life of its citizens
- To encourage innovation and entrepreneurship
- To provide protection against disaster and calamities
- To improve on the country’s human capital
- To reward veterans and their dependents for past contributions and present needs
Individuals and small businesses with little or no seed capital or collateral may find the conditions for a market rate loan unaffordable. Low cost government loans attempt to bridge this capital gap for deserving individuals and parties, thus enabling long term benefits for the recipients and the nation.
Government Loans Differ from Private Loans
Government loans are usually offered at discounted interest rates compared to those offered by private lenders. Private loans from commercial lenders come at comparatively higher interest mostly requiring guarantees through cosigners. They also may not offer all the other benefits of government loans listed above.
Other comparative benefits of government loans include fixed and subsidized interest rates, no credit history checks, allowing deferred payment, flexible income-based repayment plans, no pre-payment penalties, and partial loan forgiveness if the borrower chooses public service. For example, student loans in the U.S. may be forgiven after a period of years if the graduate works in the public or non-profit sector. (To learn more, read All About Student Loans.)
Because government loans often have more attractive terms than market-rate loans, demand for them is large. Consequently, selection criteria can be quite exacting. The application process is also time consuming, requiring paperwork and proof of financial need and deserving status on strict deadlines.
Different Types of Government Loans in the U.S.
The U.S. government offers loans in the following areas. Other countries may have slight variants, but these categories hold broadly across the globe for government loans.
- Agriculture, rural and farm service loans
Aimed at offering financial provisions to encourage farming leading to food security and rural development, several loan programs are available under the heading agriculture and farm services loans. Capital allows purchase of livestock, feed, farm machinery, equipment and even farmland within the eligibility criteria. Loans are also available for constructing on-farm storage, cold-storage, processing and handling facilities for selected commodities, cereals, fruits & vegetables, and even renewable biomass. Other available loans cover fisheries, financing for aquaculture, mariculture and commercial fishing industries. The dedicated “Rural Housing Farm Labor Housing Loans and Grants” loan program offers capital for development and maintenance of housing for domestic farm laborers.
- Business and industrial loans
No country or community can flourish with a stagnant marketplace. Innovation, entrepreneurship, employment and healthy competitiveness are a must for overall development of the economy and the nation. The various loan programs offered in the business and industrial loan category aim to encourage these aspects of development by offering easy access to required capital for deserving businesses and industries. Eligibility for most business loans is based on aspects of the business, rather than the owners. Business loans are available for small, mid-sized and large businesses and industries for various periods of time.
Capital can be used towards purchase of land, facilities, equipment, machinery and repair for any business-specific needs. Other unique and interesting variants in these government loan programs include offering management assistance to qualifying small start-ups with high growth potential and for capital requirements of transportation-related contracts among others.
- Educational loans
Educational loans, those intended to fund undergraduate and graduate college education or specific research related courses, constitute one of the biggest loan types for individuals. Featured research-focused courses, especially in healthcare areas like AIDS, clinical, contraception, infertility, nursing, and pediatric research, each have dedicated loan programs. The government can also fund foreign education of aspiring students for unique research or courses available only at foreign locations. Additional conditions, like working in public service upon graduation and so on, may be attached to loans for foreign programs.
Educational loans are considered to be the riskiest category for lenders and sponsors as such loans are heavily dependent on individuals and may not be backed by a physical collateral (like property in case of home loans).
- Housing and urban development loans
The largest part of the government loan pie is for financing home loans. This category has the largest number of loan programs including loans available for making homes energy efficient, loans for interest rate reduction, home repair and improvements, and loans for specific communities (e.g. first time home buyers, Native Americans, rural applicants, veterans, etc.). These loans are considered to be the safest from the point of view of lender (and sponsor), as they are secured by physical property as collateral in case of default.
- Loans for veterans
The Federal government provides federal benefits to eligible service members including veterans, reservists, National Guard and certain surviving spouses to obtain, retain and adapt a home and to refinance their loans. Financial benefits may include other expenses as offered by various programs.
- Disaster relief loans
Disaster relief loans offer coverage for damages arising natural and man-made disasters for farming, housing and commercial businesses. Businesses may also be covered for the absence of key employees who serve in the military and have been called up for military service (e.g. the Military Reservist Economic Injury Disaster Loan Program). If a business, farm, house or other property is hit by a disaster and the location is declared a disaster area, such disaster relief loans come to the rescue of owners and workers, who can obtain relief to re-establish themselves as well as their businesses and properties destroyed by the calamity.
Rationale for Government Loans
Loan-seeking individuals and businesses benefit from government loans through easy, low-cost access to required capital. But what’s in it for the government, and why does the government offer discounted rates for its loans?
A primary responsibility of the government is to level the playing field for deserving borrowers. Government achieves this by either offering subsidies or offering tenured capital in the form of loans.
Subsidies are usually limited to a select but significant group of candidates and don’t require the recipient to repay the government.
Loans provide benefits to both borrowers and the government as a lender. They make capital available to deserving borrowers, and the government’s initial capital is returned with interest.
The government bears the risk of default in loan repayment. Government subsidized housing loans are safer because they are backed by real property. Educational loans are the riskiest because they depend more on the fortunes of the individual borrower. However, a recent interesting report by the Congressional Budget Office indicates a profitable story for student loans. Additionally, the profit raised may be used to fund other, worthy projects. All in all, along with the risk, government loans offer a win-win situation for borrowers and government.
How Government Loans Work
Government loans may or may not be funded by the government, but all government loans are secured (or guaranteed) by the government. When the government funds a loan, it provides the loan capital. When the government only secures a loan, it effectively cosigns with the borrower on funds provided by designated lenders like private banks or government sponsored enterprises (GSEs). This means if the end-borrower defaults on loan repayment, the government has to repay the lender. Since government uses tax payers’ money, the money originates from tax payers.
Subsidized loans are loans for which a third party (other than the end-borrower) pays the interest on a loan for a finite period of time depending on the loan type. Such parties can be the government, recognized institutes or charity organizations who pay the interest on behalf of the borrower to the lender during a set period. For a loan subsidized by the government, it is usually the national or state government (or its designated agencies or institutes) which offer the subsidy.
Unsubsidized loans require the borrower to pay all interest costs, right from day one of the loan amount being disbursed.
This is why government loans are popular, especially in the U.S. Once a borrower has been deemed eligible, the benefits of subsidized rates, easy repayment options, deferred payments and other benefits make them most attractive.
Impact of Government Loans on Local and Foreign Economies
On the positive side, offering low-cost capital through government loans to qualified candidates enables many benefits for society and the economy. Government loans:
- Nurture the right talent to develop human capital (through education loans)
- Allow entrepreneurs to come up with innovative and life changing products and services (through business loans)
- Offer better quality of life to citizens (through housing loans)
- Offer security and stability (through disaster recovery loans)
- Enable food security (through agriculture loans)
- Reward veterans for their contributions (veterans benefits loans)
On the other hand, loans are liabilities until they are paid off completely. It is important to understand the financial implications of getting present day access to capital, for a future commitment to be fulfilled over many years.
According to a post on the Consumer Financial Protection Bureau website, student loan debt has increased significantly, to $1.2 trillion as of July 2013 with $1 trillion of that debt guaranteed by the federal government. Of the total federal debt (around $16.6 trillion), student loan debt alone constitutes a whopping 6%. High levels of debt may create drag on the economy in the form of lower consumer spending or higher interest rates.
In case of default on government loans, the taxpayers (and hence the national economy) bear the burden of the sunk costs.