Suppose you’re currently scouring the market for a mortgage.
In that case, you’re likely to be inundated with a variety of different options, one of which could be a collateral mortgage.
A collateral mortgage combines the attributes of a traditional mortgage and a line of credit.
As you pay down the mortgage or your home’s value rises, the amount you can borrow through your home’s line of credit increases.
What Is a Collateral Mortgage?
A collateral mortgage falls under the category of re-advanceable mortgage products.
These mortgages provide homeowners with access to a line of credit, usually referred to as a home equity line of credit (HELOC).
The amount you’re allowed to borrow through your HELOC increases as you build up equity in your home.
Under a collateral mortgage agreement, you pledge your property as security, which your lender can seize and liquidate if you default on your payment obligations.
When you apply for a collateral mortgage, your lender has the option to register your loan for an amount that exceeds the actual mortgage.
This amount is referred to as the collateral charge and can reach as high as 125% of your home’s appraised value.
This means that you’ll be able to borrow funds through the HELOC based on 125% of the current value should your property’s value increase over time.
Did You Know?
Canada’s six major banks – RBC, TD, CIBC, BMO, Scotiabank, and National Bank – offer collateral mortgages.
Example of a Collateral Mortgage
Suppose you purchase a home for $500,000 and decide to get a collateral mortgage.
You contribute $140,000 as a down payment (28%) and thus require financing for the remaining $360,000.
Assume your lender approves your application and registers your mortgage with a 125% collateral charge, translating to $625,000 ($500,000 x 125%).
The maximum amount you can borrow through the mortgage’s attached HELOC is 80% of your home’s value, less your mortgage balance owing.
In this example, your home’s present value is $500,000 and your balance owing is $360,000.
Thus, you can draw up to $40,000 in home equity.
Years later, your mortgage balance decreases to $310,000 and your home’s appraised value is now $550,000.
What this means is you’ll have $130,000 available to borrow ($550,000 x 80% – $310,000).
What’s vital to keep in mind is the maximum equity you’ll be able to access is equal to the amount registered on your collateral mortgage, which in this case is $625,000.
Your home’s value would have to increase to $781,250, and your mortgage balance would have to be paid in full for you to access this amount ($781,250 x 80% – $0 mortgage balance).
Advantages of a Collateral Mortgage
The primary advantage of a collateral mortgage is that it doesn’t require you to refinance to gain access to your property’s equity.
Additionally, you’ll avoid the legal and administrative fees customarily associated with refinancing.
Another advantage of a collateral mortgage is that your borrowing capacity increases if your home’s value rises.
As a result, you don’t have to rely solely on paying down your mortgage to boost your home equity.
Disadvantages of a Collateral Mortgage
If you opt for a collateral mortgage, you’ll face more significant hurdles when trying to break the mortgage contract with your lender, should you choose to do so in the future.
Even if it’s up for renewal, cancelling a collateral mortgage usually entails hiring a lawyer, which can be costly.
Another disadvantage of a collateral mortgage is the danger of accumulating too much debt by borrowing against your home’s equity, to the point where you struggle to keep up with the payments.
The same scenario applies to consolidating other debt (credit cards, personal loans, etc.) with your collateral mortgage.
In both cases, you risk losing your home if you fail to make timely payments.
Lenders are more inclined to seize your property quickly if it’s secured through a collateral mortgage instead of a standard one.
Also, since your lender may register a collateral charge for more than your home’s value, other lenders may be hesitant to extend credit to you.
The reason for this is because, on paper, it will look like you’re carrying more debt than you are.
Your lender retains the right to set a new interest rate on your collateral mortgage any time they wish if it’s a variable-rate contract, so be sure to check what rate terms they’ve registered to avoid being caught off guard.
Collateral Mortgage vs Conventional Mortgage
The main difference between a collateral mortgage and a conventional mortgage is that the former doesn’t necessitate refinancing to access home equity.
With a conventional mortgage, refinancing or a separate home equity line of credit is required to access equity in your home.
Another difference is that your lender doesn’t register your property with your municipality’s registry office under a collateral mortgage.
As a result, a collateral mortgage remains registered with your lender, who also has the sole right to discharge it.
You can’t transfer your mortgage to an alternative lender, at least not without incurring legal fees to break it.
Conversely, a conventional mortgage is registered with a municipal registry office, which means it’s transferable.
You can easily switch to a new lender when your mortgage term ends without going through an arduous and costly legal process.
Frequently Asked Questions
- Is a collateral mortgage bad?
A collateral mortgage can be beneficial or detrimental – it depends on your financial circumstances.
Suppose your finances are in stellar shape, and you can acquire a collateral mortgage with a low interest rate. In that case, you’ll likely experience little difficulty in keeping up with payments, both on the mortgage and any funds you borrow through the line of credit.
Conversely, suppose your financial situation rapidly deteriorates. In that case, you can quickly fall behind on your payments, putting your home in danger of foreclosure. If you’re risk-averse or financially vulnerable, it’s probably wise to avoid a collateral mortgage.
- Are all TD mortgages collateral?
Yes. As of October 18, 2011, Toronto Dominion (TD) Bank registers each mortgage it issues as a collateral mortgage.