Disclaimer: I am not a lawyer. This is one of those topics that causes heart burn for individuals and businesses that may be unfamiliar with how banks and lenders operate. This topic is almost as bad as discussing bank fees – but not quite. What is a guarantee? A guarantee is an agreement that either you or your company is liable for a debt or obligation. There are 2 basic kinds of guarantees: personal and corporate. A personal guarantee means you are liable for a debt or obligation and a corporate guarantee means your company is liable for a debt or obligation. So what’s the big deal?
For some, the big deal is that guarantees are additional security for a mortgage or loan. If you default on your mortgage or loan the bank or lender can pursue you to get at your other assets as part of ensuring the debt obligation is repaid. For example, if you borrow $1,000,000 and pledge a property or business assets as security the bank or lender will still ask for a personal guarantee of $1,000,000 which means your personal net worth would need to be at least $1,000,000 in order to qualify.
This can be a problem if you have borrowed money from multiple banks or lenders and each of them have a claim to your personal guarantee (or corporate guarantee). The reason it is a problem is because the order in which they registered their interest in you takes priority in the same order. For example, you may have borrowed money from TD Bank and then CIBC for two separate transactions and if you defaulted TD Bank would have a priority ahead of CIBC if they made a claim against your guarantee. This could mean that a bank or lender may choose to decline your application simply because of the amount of guarantees you have outstanding and where they would end up in priority.
“But Dylan, I gave the bank a mortgage or the lender has my accounts receivable – isn’t this like double coverage?” You’re right. I have a client right now who has a great project but because of the multiple deals he has done with multiple banks we are having a difficult time getting a commitment for his project as the banks do not want to be behind the existing creditors on his guarantee.
So what do you do?
Make sure you know how much net worth you have and the value of the personal guarantees you have signed. Work with the bank or lender to get a reduce personal guarantee if you can. For example, if you are borrowing $1,000,000 and a personal guarantee is required ask the bank if they would accept a 50% personal guarantee or even 25%. This would mean you are only obligated to personally pay $500,000 or $250,000 in the event that the bank makes a claim against your guarantee.
As stated, I am not a lawyer and understanding how guarantees work is important. You should chat with your lawyer about them to see what you need to know.
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“Credit is a system whereby a person who cannot pay gets another person who cannot pay to guarantee that he can pay.” – Charles Dickens
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