If your lender has ever offered – or only offers – you a collateral mortgage, your first reaction might be to jump on it and accept. Collateral mortgages are a readvanceable mortgage product. With one, your lender has the ability to lend you more money as your property value increases, without ever having to refinance your mortgage. If you think you’ll need to borrow more money at any point throughout your mortgage term, a collateral mortgage will save you money on legal fees and the costs of refinancing your mortgage. (And who doesn’t like to save money?)
Unfortunately, there’s more to think about, before you accept such an appealing offer. Here are two things you should consider before taking out a collateral mortgage:
1. On paper, it could make you look like you have more debt than you actually do.
With a collateral mortgage, your lender registers your home with a collateral charge – similar to what they do if you got a home equity line of credit – and they have the ability to do so for an amount higher (up to 125% of the value of your new home) than the actual value of your home. For example, if you bought a home for $450,000, your lender could potentially register your home for a value of up to $562,500 ($450,000 x 125%).
On paper, this collateral charge could make you look like you have more debt than you actually do. If, sometime throughout your mortgage, you wanted to secure secondary financing for other things, a lender would have to review your credit history and would see this larger amount registered under your name. Even though you wouldn’t actually have a $562,500 debt, they could see it as though you do. And, depending on your financial situation at the time, this may be reason enough for them to decline your application for more financing.
2. You can’t transfer it to another lender – at least not without the help of a real estate lawyer.
While the first point should be on your radar, perhaps the most important thing to consider before taking out a collateral mortgage is that it cannot be transferred to another lender – not even at the end of your mortgage term. The reason it can’t be transferred is because collateral loan agreements aren’t registered with your land title or registry office. Instead, they’re registered under the Personal Property Security Act (PPSA) of Canada. For that reason, it may contain terms and conditions that other lenders don’t agree with. So, if you ever decided to switch providers, you would need to hire a real estate lawyer to help get you out of your collateral loan agreement. (So much for saving money on legal fees!)
Depending on which lender you decide to get your mortgage from, you may or may not have a choice on whether you’ll get a collateral mortgage. TD Bank (as of October 18, 2010) and ING DIRECT (as of December 10, 2011) only offer collateral mortgages, while a few other lenders offer both.
Now, none of this is to say that you shouldn’t get a collateral mortgage. Like we said, if you think you’ll want to borrow money from your home in the future, having a collateral mortgage will save you money on legal fees and the costs of a refinance – and we’re all for helping Canadians save money! But our top priority is to give consumers the information they need to make educated financial decisions. So, when you’re discussing your mortgage options, make sure to ask your mortgage broker if the product you’re considering is a collateral mortgage or not, and decide if getting one is a good idea for you.