A collateral mortgage is a readvanceable mortgage product. This means that the bank or credit union can lend you more money as the value of your property increases or as you pay down your current mortgage balance. This can save you from having to refinance your mortgage to access equity as your home value increases. In order to do so, the lender must register your home with a collateral charge, which gives them the ability to re-advance or lend you a higher amount in the future. A collateral mortgage can be simply a fixed mortgage or it can have a line of credit attached to it allowing you convenient access to the equity in your home.
The Benefits of a Collateral Mortgage
There are some benefits to getting a collateral mortgage for your next home. It gives you the ability to avoid the legal costs that you have to pay with refinancing your home down the road. With a line of credit attached to your mortgage it gives you the flexibility to borrow money at any time and access the equity you have built up, keeping in mind you can only refinance or access up to 80% of the homes appraised value. For example if you are buying or refinancing your home and you have at least 20% down then one of these types of mortgages may be of interest to you for fast access for renovations, large purchases like a vehicle or to help support children with secondary education costs.
The Pitfalls of a Collateral Mortgage
There are a couple downfalls to having a collateral mortgage. For one, a collateral mortgage is non-transferable which means you cannot switch your mortgage to another lender at renewal time. This takes away your choice and ability to choose another lender who may be offering a more competitive rate and term. With a standard charge mortgage you can switch lenders at renewal with no cost, with a collateral charge you would have to refinance and incur legal and appraisal costs if you are mortgaged at 80% of your homes’ value, if you are still above 80% or in an insured mortgage you have no choice but to stay with the current lender. Some banks only offer collateral mortgages and it can be a retention strategy so you are more likely to stay or are literally stuck, even at a higher rate.
Depending on the amount of collateral mortgage registered this could also effectively tie up all of your equity in your home. Some lenders register for the mortgage amount, some the property value and some 120% of the value of the property. This could be a concern or you – if you ever had a financial hiccup or an emergency there is no way to access the equity in your home even in the form of a short-term second mortgage.
Let’s put this into a real life example: your home is worth $400,000 and you have a $300,000 mortgage and $100,000 in equity. You need $40,000 quickly (and unexpectedly) to:
• buy out your business partner who is leaving the business;
• you have damages that are not covered in your home insurance and have to do major renovations;
• you have an illness in the family that requires a short leave and additional expenses;
• or you have unexpected legal costs.
In all of these situations, the quickest way to access your equity would be with a second mortgage for a short term – you don’t want to pay any large penalties for breaking your mortgage early. But wait – you have a collateral mortgage that is registered for the full value (or greater) of the home, unfortunately that leaves you with no choice and no access to your equity.
Is a Collateral Mortgage Right for You?
After you’ve picked your next home and your offer has been accepted, you will need to sit down with your mortgage broker to prepare your financing. It is important to know all your options up front. Some banks only offer collateral mortgages and some offer specific types of mortgages products that are collateral.
The benefit of working with a mortgage broker is the choice of over 30 different lenders so you can choose the mortgage that fits your needs.
For advice on collateral mortgages and if they are right for you, contact The Mortgage Advisors today.