In Canada, the collateral mortgage is a specific type of loan that you may (or may not) want attached to your real estate purchase. As with any financial option, it has benefits and drawbacks that you will want to consider before making your decision.
Collateral Mortgage Definition
So what is a collateral mortgage vs. mortgage? First, let’s review the definition of a conventional mortgage. When you sign the paperwork for a conventional mortgage on your property, you know the periodic payments, your interest rate, the period of amortization and the date that your mortgage will be up for renewal. You’ll also know when the mortgage will be paid in full, if the interest rate does not change at renewals. For example, if you buy a home for $440,000, and you go to the bank and get a conventional mortgage of $352,000 (meaning you put down 20 percent, or $88,000), with a five year term fixed rate loan of 4.00 percent, on an amortization basis of 25 years, then you would have a monthly mortgage payment of $1,841.08. If you make all of your payments on time, you can renew after five years. You’ll be subject to market interest rates at that time, which means your payment may go up. At this point, you can transfer your loan to other lenders, if you can find a better deal there. You also have the option to take out a home equity loan if needed.
A collateral mortgage is less formal; instead, it is simply a promissory note that is secured with your home. There are many lenders who will come to you with the chance to register your mortgage for up to 125% of the property’s value. In the previous example, they could register that collateral mortgage for $550,000 ($440,000 x 1.25). However, you would still only get the $352,000. You do have the ability to go back to the lender and take out as much as that registered limit (assuming the lender approves) without having to go and register a second mortgage. This makes it easier to get access to your home equity or to additional financing.
However, there are some disadvantages associated with a collateral mortgage as well. First of all, you can’t transfer a collateral mortgage to another lender at the end of the maturity period. If you want to change to another lender, you have to discharge that collateral mortgage and pay the fees for new mortgage registration. This takes away your right as a consumer to shop around and look for a better interest rate during the renewal period.
Also, Canadian law provides for an “offset” tactic with your loan. If you have defaulted on a credit card or other loan that was also issued by the lender who gave you the collateral loan, that lender can increase your balance on your collateral mortgage to satisfy that debt without your approval.
Finally, if you want to increase your debt closer to the registered amount in order to consolidate some other debts, renovate your house or for other purposes, and this lender will not let you, you won’t be able to go to another lender to look at a home equity loan. With a collateral mortgage, the registration process occupies all of your equity until the loan ends.
For this reason, it is important to know whether the loan you are being offered is a conventional or collateral mortgage. If you are looking for a combo loan where some of the financing consists of a line of credit, all of the main banks consider these to be collateral charges.
So why would you take out a collateral loan? If you think you are going to need to add to your loan and you don’t want to pay refinancing fees, then they make sense. However, if you aren’t planning on doing this, and you are going through a traditional lender, be sure to find out whether the loan on the table is conventional or collateral. TD Waterhouse ran into some negative press from a CBC investigative report, when it came out that TD was not explaining that its mortgages were collateral until the signing date, at which point choosing another lender is not an option.
Collateral Mortgage vs Conventional Mortgage
What is a collateral mortgage vs. mortgage? Collateral Real Estate Mortgage work a little bit differently. While a conventional mortgage might start out with a principal of $100,000, you just make one monthly payment on the basis of that initial principal and your interest rate. With a collateral mortgage, you can split that $100,000 in a number of ways, such as splitting it into multiple loans, opening up a line of credit and even having a credit card to carry around, and all of these products are based on your home as collateral. Many banks offer these at a lower interest rate with higher limits of credit. No wonder, of course, because banks like having this sort of leverage over their borrowers.
For those who are considering the differences between a conventional and a collateral mortgage, understanding the various terms is an important part of getting the right loan for your home purchase. While collateral mortgages do offer a bit more flexibility in terms of getting liquidity out of your house, when you reach the end of your mortgage contract and it is time to re-up, you can end up being forced to sell your house. This doesn’t mean that a collateral mortgage is not right for you, but it is important to know what you are in for when you sign this type of agreement.
With a conventional mortgage, you have one loan out from a bank or other lender, and you make monthly payments on that loan. At the end of the term, if it’s not paid off, you simply renew the contract with your existing bank, or you find another lender to take it over. There is no cost to the borrower for changing over to another lender. The conventional mortgage already has amortization in place, with registration against the title, so a new lender would just take over the existing amortization and balance from the previous loan.
Pros and Cons of Collateral Mortgages
The risk comes when it’s time for a mortgage contract to come to an end. With the conventional mortgage, you can shift your loan over to another lender for no charge. However, with a collateral mortgage, you have to pay an attorney to discharge that first mortgage and register the new one, which can end up costing as much as $1,000. You also have to pay off any lines of credit or credit cards that you had open as a result of your home’s value before you can move to the new mortgage.
This isn’t where the bad news ends, unfortunately. Technically, under Canadian guidelines, changing a collateral mortgage is considered a refinance of your home loan, and you can’t refinance for more than 80 percent of the value of the property. So if you owe more than 80 percent of the value of your property, you can get stuck with your lender until you have paid down your principal or until the value of your home goes up. A lot of lenders are selling collateral mortgages as a way to retain business, because even if you are willing to pay the attorney’s fees, if you owe enough on your house, you might not even be able to switch over to the other lender at all, because of the loan to value limits in place. Because some banks have not told new lenders about these restrictions before getting them to sign collateral mortgage agreements, these mortgages have turned into sneaky traps for too many homeowners.
At Amansad Financial, our position is that a homeowner should never put all their eggs in one basket for the long term. By allowing your financial institution to collateralize your mortgage, your essentially giving them control moving forward and may cause more grief than convenience. While we do have connections with lenders providing collateral mortgages, we urge our customers to diversify their debt. If you have a credit card, do not have it with the same lender who issued your mortgage. You don’t want to end up stuck with a high rate when it’s time to renew your mortgage simply because your collateral mortgage agreement has you tied down. Instead, if you are going to have a tough time making a big dent in your principal, consider a conventional mortgage.
If you have questions about your own pending loan, Amansad Financial can connect you with a number of resources that will help you make an informed decision. Give one of our specialists a call today!