What is a Payment Guarantee?
A payment guarantee is a type of financial commitment that requires the debtor to repay the debt in accordance with the terms and conditions that apply to the original debt agreement. In some cases, the guarantee is backed with the use of some type of collateral, such as property or some other type of asset that is acceptable to the lender. There are different kinds of guarantees used in various business settings, such as the working agreements between importers and exporters, or suppliers of goods and services who require a guarantee from a parent company when doing business with a subsidiary.
One of the more common types of guarantees is utilized with many import-export transactions. In this situation, the seller may require what is known as an advance payment guarantee. The amount of the guarantee may be the full price of the goods that are to be shipped, or a specific percentage of that amount. Generally, the funds are kept on deposit at the seller’s bank until the order is shipped, received, and accepted by the buyer. At that point, the funds are released to the seller, and any remaining payment is made. Should the seller fail to ship the goods according to terms, or the received order is incorrect, the buyer can exercise the payment guarantee if the seller is not willing to take steps to fulfill his or her contractual obligations.
A payment guarantee may be required when the credit of a potential borrower is not considered sufficient to meet the standards set in place by the lender. For example, if a bank feels that a subsidiary of a larger company is not a good credit risk, the bank may require that the parent of the subsidiary pledge some type of collateral. The collateral serves as a means of ensuring that even in the event of a default, the lender will still receive full compensation for the loan. The same general idea may be used when individuals with less than ideal credit wish to receive a loan. As long as a third party will agree to guarantee the repayment of the loan, a measure that reduces the risk assumed by the lender, the loan has a better chance of being approved.
Depending on the circumstances, the payment guarantee may take on several different forms. In some cases, the agreement is recorded in a formal letter of guarantee that is issued by the third party and addressed to the lender. A check guarantee provides an actual check drawn on an account owned by the third party, and is held as collateral for the loan. A formal money back guarantee is often included in the payment guarantee, effectively committing the seller to follow through with all commitments involved in the transaction, or be required to reimburse the buyer in full if those commitments are not honored according to the provisions of the contract connected with the transaction.
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