What Is The Difference Between A Collateral Mortgage And A Conventional Mortgage?
There is a growing trend with the major banks and some credit unions to now register a collateral mortgage charge instead of a conventional mortgage charge when you enter into a new mortgage agreement with them.
Traditionally, a collateral mortgage charge was primarily used with line of credit accounts where there can be a considerable difference between the amount advanced and the amount outstanding at any point in time.
The basic workings of a collateral mortgage is that the mortgage lender actually has a promissory note and secondary security in the form of a first or second lien against the property for the total amount registered, which can be as high as 125% of the property value even though the borrower did not receive the amount registered.
A collateral mortgage allows the borrower to provide additional principal or re issue principal that has already been paid back similar to how a line of credit works.
With a conventional mortgage, the amount being borrowed, interest rate, and repayment schedule are all basically fixed and the lien registration reflects the amount advanced.
With a collateral mortgage, the big difference is in the terms and conditions.
In addition to the higher loan registration amount lenders also have the right to write in a higher interest rate that what is initially being offered and charged to the customer. For instance, the collateral mortgage may have a stated interest rate of 10%, but the customer is only being charged prime plus 1% initially.
What Is The Reason For Mortgage Lenders To Now Move To Collateral Mortgages?
From the lender’s point of view, they promote this as providing more options and convenience to the borrower. Because of the amount of security being pledged to the lender, the borrower can more easily qualify for additional borrowings with the bank. This could include any non mortgage form of borrowing as well.
The banks also explain that a borrower can more easily move from one lending product to another without incurring any new mortgage registration charges.
And while the consumer can receive value from signing off on a collateral charge, there are some things you should be aware of before accepting this type of mortgage option.
Things To Be Aware Of With Collateral Mortgages
First, by registering a collateral mortgage at 100% or high of the fair value of your property against your property, any future borrowings that you may want to leverage from your home will likely have to come from the collateral mortgage holder. For instance, if you wanted to secure a second mortgage where the total loans outstanding would be less than 80% of the value of the property, no second mortgage could be arranged from a different lender because they would have to register behind the collateral mortgage which may be listed at 125% of the property value, even though only a fraction of that amount may be outstanding.
This could also impact your ability to qualify for any type of lending program outside of what your primary mortgage lender is offering due to the fact that other lenders will likely consider the full amount of the mortgage registered in their debt service calculations. So even though you have good income and credit, you could still be viewed to have an excessive debt load, causing otherwise straight forward credit applications to be declined.
Second, the nature of the way the collateral mortgage will likely be written, will allow the lender to utilize it as security for any other loans, credit cards, and lines of credit you may have with them. Effectively, they may be able to become fully secured by real estate for any and all borrowings made to you once the collateral mortgage is put into place.
Third, if you do fall behind on your mortgage payments, the collateral mortgage provides the right for the lender to potentially start charging a higher rate of interest if a higher rate is written in compared to what you are initially paying. Because the lender has such a strong securing position, they can justify the increase to cover a higher risk of repayment default while not really having any real risk of potential loss. The end result is even if you get back on track, you now have a higher interest rate to pay, which can lead to higher prepayment penalties if you try to move your mortgage to another lender.
Should I Consider A Collateral Mortgage Or Just Stick To A Conventional Mortgage?
This is one of those depends answers.
Currently in the market place, some lenders are providing the customer with an option of taking a conventional mortgage or a collateral mortgage.
However, this is not true with all lenders and this fall, some mortgage providers are talking about only offering a collateral mortgage option.
Because banks offer a fast closing process which tends to be cheaper than going through your own lawyer, many borrowers are going to sign off on a collateral mortgage without really understanding the pros and cons.
So the key here is understanding what you’re signing up for.
If the benefits of a collateral mortgage fit your needs, then there is certainly nothing wrong with accepting this type of mortgage offer.
But if the terms and conditions are going to be too restrictive for your future financial planning and cash flow management requirements, then a conventional mortgage may make more sense.
Before signing off on any mortgage offering, make sure you are getting independent legal advise if you’re not completely sure as to how all the terms and conditions of mortgage work.
That way you can make an informed decision and have less chance of regretting it at some future date.
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