Understanding Mortgage with Collateral Guarantee

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Does the idea of a massive down payment hold you back from your real estate project? Good news: a collateral guarantee could be the key. This solution allows you to leverage the value of your existing property as financial backing for purchasing a new home. Learn how this strategy works and decide to bring your acquisition project to life.

How Does a Collateral Guarantee Work?

Do you want to buy a new property but lack the initial down payment typically required by financial institutions? When a buyer takes out a traditional mortgage loan, they usually need to provide a sum representing a percentage of the purchase price, generally between 5% and 20% of the property’s value.

A collateral guarantee is one of the solutions suited to your project. It can effectively replace the traditional down payment:

Instead of providing a cash down payment, you use the net value of your property as the down payment. Your home equity is used as security to obtain your new mortgage.
No cash transfer occurs between your properties: your existing property essentially serves as collateral to secure the repayment of the financing for your new purchase.
With a collateral guarantee, you can even finance a significant portion of your new property’s purchase price. This solution allows you to finance up to 100% of your new home’s price.

Assets Used as Collateral Guarantee

Different Types of Real Estate

Various types of properties can be used as collateral guarantee, including:

Land,
Houses,
Income-generating buildings,
Cottages.

Who Owns These Assets?

Several ownership situations may arise:

The property may belong to you directly.
It may also belong to close family members, such as your parents, brothers, or sisters. In this case, property owners must sign the necessary documents to formalize the guarantee. This situation may occur when parents wish to help their child acquire real estate without becoming co-borrowers, co-buyers, or co-owners.

What Happens If the Property Is Under a Mortgage?

The collateral guarantee can apply to a property financed through an existing mortgage or to a fully paid property.

If a mortgage already encumbers the property used as collateral for residential financing, the new funding must be obtained from the same lending institution.

How Much Can I Borrow with a Collateral Guarantee?

An important rule to remember when determining the amount you can use as collateral is the 80% rule. The maximum financing amount generally equals 80% of the value of the properties given as collateral, including the new property you wish to acquire.

Example:

You own a house worth $500,000 and still owe $250,000 on your mortgage.
Your available equity is calculated as follows:
($500,000 × 80%) – $250,000 = $150,000
This $150,000 can then be used as collateral.
If the new property you are considering costs $600,000, it is possible to finance it 100% since the total financing ($250,000 + $600,000 = $850,000) does not exceed 80% of the combined value of both houses:

$500,000 + $600,000 = $1,100,000, 80% of which equals $880,000.

Therefore, a 100% mortgage can be granted for the new property.

Comparison: Conventional Mortgage vs. Collateral Mortgage

Understanding the differences between conventional and collateral mortgages helps you make an informed decision based on your situation. Here are some key characteristics of each option:

Want to Transfer Your Mortgage?

A conventional mortgage offers greater flexibility at renewal, typically every five years. This allows you to switch lenders more efficiently and at a lower cost.
With a collateral mortgage, you generally cannot transfer your contract to another lender. However, there is an exception: If your loan balance is less than 80% of your property’s value, transferring the mortgage and releasing the asset used as collateral may be possible. You should also expect to pay discharge fees for the collateral charge.

Cost Differences

A conventional mortgage offers more flexibility when switching lenders, typically with lower costs associated with the transfer.
A collateral mortgage offers less flexibility and usually involves additional fees.

Why Choose a Collateral Mortgage?

Several advantages come with taking out a collateral mortgage:

Opportunity to reinvest in real estate without needing an initial down payment. This is particularly useful for buyers who already own property with some equity but lack the cash for a down payment on a new purchase.
No interest payments are made on the property used as collateral since no funds are transferred between properties. However, if the collateral property already has a mortgage, those mortgage payments must still be made.
Avoiding mortgage insurance from providers like the Canada Mortgage and Housing Corporation (CMHC) can lower borrowing costs.
Easier mortgage approval—If you own a property, you can use it as collateral to facilitate obtaining a new mortgage.
Greater flexibility with the possibility of negotiating better terms, such as a lower interest rate or more flexible repayment options.
More substantial financial profile—offering an asset as collateral enhances your credibility with lenders and can improve your credit score by demonstrating your ability to secure financial commitments.

Collateral Guarantee: What Are the Impacts on Your Assets?

Before opting for a collateral guarantee, it is essential to understand its implications:

When a financial institution grants a collateral guarantee, it establishes a mortgage guarantee deed on one of your properties. This mechanism lets you finance the down payment required to purchase another real estate asset. In return, the new property will be mortgaged at 100%, just like a traditional mortgage.
The collateral guarantee holds the same legal value as a conventional mortgage. If you sell one of the affected properties, you must fully repay or release the collateral guarantee before finalizing the transaction.

Note: Not all financial institutions offer the collateral guarantee option. Personalized support from a mortgage broker can help you assess your options and navigate the sometimes complex world of mortgage financing.

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