By Holger Reinel | Updated on June 11, 2020
When homebuyers get a mortgage to buy a home, lenders have two ways to register the mortgage.
Register a conventional mortgage charge
Register a collateral mortgage charge
It sounds like a subtle difference, doesn’t it? Well, the difference is big, and banks do a terrible job informing consumers about what they are signing.
To illustrate one of the key differences, imagine your mortgage is coming up for renewal and your existing lender offers a rate that’s higher than other lenders.
Your first thought is, you will move to the bank offering a better rate, right? Well, with a collateral mortgage charge, you can’t. That’s because collateral mortgages are not transferable; those mortgages can only be registered and discharged.
But there is more. Keep reading to find out the pros and cons of collateral mortgages and how this affects your mortgage loan.
All mortgages are secured by real property (a home); that security is registered at the land registry office and it is how lenders can foreclose on a home. A foreclosure can happen when the homeowner breaches the contract, such as when there are missed payments.
A collateral mortgage charge is then registered under the Personal Property Security Act (PPSA) and cannot be transferred to other lenders the way conventional mortgage can.
The only way to transfer to a different lender is to discharge the mortgage (pay it off) by applying for a brand new mortgage with a different bank; the title will then be re-registered which will cost you just under $1,000, and you will have to pay a penalty to the bank that was holding the collateral mortgage. Ouch!
While a conventional mortgage charge registers the exact amount of your mortgage, a collateral mortgage charge may register up to 125% of the value of the new home.
Yep, that’s not a typo. With a collateral mortgage, most lenders will register up to 100% of what they home is worth, but they can go up to 125%.
Because a collateral mortgage is a “re-advance-able” mortgage. Wait… what? Re-advanceable means that as you pay down the mortgage, you can borrow more money up to the amount registered by the lender at the registry office.
But there is a catch, if you want to borrow more money, the lender still needs to approve the additional loan.
For example, let’s say you buy a home worth $600,000, and you make a $60,000 down payment, (10% of the purchase price), so (excluding land transfer tax) you require a mortgage for $540,000.
Using the maximum loan-to-value ratio of 125%, the lender could register a charge for $750,000 ($600,000 * 125%), even though the actual mortgage that you received is only for $540,000.
As I said earlier, most lenders will register a collateral loan for 100% of what the home is worth and not 125%. You can then be approved for a line of credit for the total of the equity you have in the home. That is, of course, if you get approved.
Let’s say that three years ago you got a mortgage and you borrowed 90% of the home’s value; the bank registered 125%. Also, let’s assume that this year you need to replace the roof, but you’re having trouble making ends meet because even though you’re now working, you spent three months without work.
You contact the bank to get for an increase on your line of credit, but the bank declines you because your credit score took a hit recently.
Because the lender has locked 125% of the home’s value, your only option is to break the mortgage and re-borrow the entire amount elsewhere, but you’ll have to face all the penalties. That’s expensive!
The main advantage of a collateral mortgage is being able to access the equity you build as you pay to pay down the loan.
Because the lender may register the mortgage charge for an amount higher than the initial loan, you can easily access more money from this lender using your home as security. Here are more additional benefits:
Collateral mortgages have an available line of credit component and the amount is available to you use at any time.
If you anticipate the need for a line of credit or future home renovations vs. paying down the loan as soon as possible, then collateral mortgages are a good option.
Sounds convenient? It is, but that convenience has a downside that’s too big to ignore.
While collateral mortgages are convenient to some people, there are a few important disadvantages like the following:
You cannot transfer the mortgage to a different lender; to get a mortgage loan with a different lender you will have to discharge the collateral mortgage first and you will be forced to pay a discharge fee and penalties.
To switch to another lender, you will have to pay legal fees.
Other lenders will likely turn you down from additional loans such as a car loan etc. because on paper, it will look as if you have more debt than what you owe.
Even though in theory, you can borrow more money from your existing lender, you will still need their approval.
Collateral mortgages allow very little room for you to apply for additional mortgage loans with other lenders because the first lender would have locked up 100% (or more) of the value of the property.
With a standard mortgage charge, there is a level of predictability for second mortgage lenders, because the amount you owe is the same amount that is registered.
However, with a collateral mortgage, your existing lender can secure, not just your current debt, but also any future debt with that same lender.
This essentially means additional lenders are left out, so the only lender you can get additional secured financing from is your existing lender. That’s not a good negotiating position to be in. Keep away from collateral mortgages!
By registering a collateral mortgage your lender will be able to secure any future debt you acquire with them such as a car loan, credit cards, or line of credit.
Any credit you acquire with the lender that holds your collateral mortgage will potentially be secured with your home. This means a higher level of protection to the lender at your expense.
But remember that simply because there is a mortgage charge that’s higher than what you owe, that does not mean you can run to the bank and access those funds. You will still need to be approved first.
So, if you’re looking for a HELOC, other lenders will be hesitant to approve that loan because any future debt you acquire with your existing lender will always have priority over the second mortgage.
This means the only place where you’d be able to get a secured loan is with your existing lender; that is if they approve you, of course.
This part will shock you
The most troubling part about collateral mortgages is that the lender can call in the loan for any reason they want. Of course, the bank wants to continue making money from you by charging you interest so that’s not something they would normally do.
However, things happen, if you didn’t pay the car loan, property taxes, your credit card, or if your credit score took a hit, the lender could call in the loan if they think there is a higher risk, and they don’t need to give a justification for it.
That’s not possible with conventional mortgages. So collateral mortgages have inherent risks borrowers need to be aware of.
It’s because a collateral mortgage is a distinct mortgage product; that’s why you have to be aware of the way collateral mortgages work so that you can make an informed decision.
There are pros and cons. From the lender’s side, this means they have a better chance to service all your banking needs.
In essence, the lender makes it cheaper for you to borrow more money from them by making it harder and more expensive for you to lend money with other lenders. It’s a lender’s dream world, but there are borrowers where this could work.
Since the lender registers the mortgage for an amount that is higher than your initial loan, you can get more loans without having to register a new charge (secondary charge) to your property which adds both convenience and flexibility to one’s potential borrowing needs.
Collateral mortgages do offer some flexibility. Having a line of credit or other loans attached to your mortgage gives you access to additional funds if needed.
The homeowner can borrow more money at any time using their home as collateral and without having to refinance anything. The lender has already secured a loan for a higher amount so even future loans are already secured, and there is no need for legal fees.
It’s a compelling argument; isn’t it? Unfortunately, though banks are not doing enough to inform borrowers about the pitfalls of collateral mortgages. That’s like granting a blanket insurance policy to your lender but you’ll be the one footing the bill.
Another reason is many homebuyers are simply not aware of the implications or don’t know the difference between a conventional mortgage and a collateral mortgage.
So they sign on the dotted line because at that point it’s too late and they need to close on their home purchase, only to wake up a few years later feeling kneecapped by their lender.
I like to think of collateral mortgages as lions; they`re fascinating to look at, but unless you’re a lion yourself, stay away from them.
Most homebuyers are looking for a mortgage they can afford, and when the mortgage is up for renewal they want to have the flexibility to switch to a different lender that offers better rates.
However, collateral mortgages offer a way to further protect the lender, but the added benefit to the borrower can be marginal. Yes, the product can be useful if you have a high likelihood of refinancing or requiring an additional loan before the maturity of the term.
But the lender will still have to approve you for the additional loan. That’s a big caveat! Thus in my view, collateral mortgages are better for the bank and not so good for customers because they give customers fewer options.
Also, the goal of a home buyer is not to get further in debt. So the convenience that comes with being able to access more funds from the equity of your home, can be a double-edged sword for most buyers.
I recommend to stay away from collateral mortgages, but if you decide that a collateral mortgage is a good fit for you, be aware of the risks so that you can plan accordingly.
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