What is a Collateral Mortgage?
When most homeowners get their first mortgage, it is usually a conventional mortgage. But conventional mortgages aren’t the only option available on the market. Some people choose to get a collateral mortgage instead.
A collateral mortgage is a mortgage product where your lender can loan you more money as the value of your home increases without the need to refinance your home loan. As a result, collateral mortgages can help you access equity in your home.
One of the most noticeable differences between conventional and collateral mortgages revolve around how the loan is treated. Collateral mortgages typically cannot be transferred by the lender and therefore need to be discharged, which can result in additional costs. Additionally, when you have a conventional mortgage, only the amount of the mortgage is registered against your home as a liability. Collateral mortgages require that an amount greater than the loan be registered.
If your lender agrees to provide you with additional funds, they would then register your home with a collateral charge. This charge is generally higher than the amount required for the loan. When your home is registered with a collateral charge, you can then borrow money from your home whenever you like without having to refinance your mortgage. In a way, this is similar to a Home Equity Line of Credit (HELOC), where you can take out equity in your home at will, provided you remain within your limits.
The collateral mortgage acts as a form of lien against your home for the entire amount of the registered collateral charge. It gives your lender an additional level of security should you default on your mortgage, and can be worth as much as 125% of the value of your property.
One reason why some people choose a collateral mortgage is because its structure makes it easier and more affordable for you to borrow additional funds from you lender. This is because you will not be required to cover the costs associated with hiring a real estate lawyer, which you would have to do if you refinanced your mortgage.
Unlike conventional mortgage products, you cannot transfer a collateral mortgage from one lender to another. Homeowners with conventional mortgages have the option to switch lenders when their mortgage term expires.
As previously mentioned, collateral mortgages must be registered with a collateral charge. Because of this, other lenders may be hesitant to agree to the terms associated with them, as the higher registered amount often resembles additional debt. If you decide to switch lenders while you have a collateral mortgage, you will likely incur additional costs and legal fees. This could set you back by a considerable amount.
In order to understand how a collateral mortgage functions, here is a scenario involving one.
In this example, let’s assume that you have purchased a home worth $500,000. With a 20% down payment – in this case, $100,000 – the value of your mortgage loan would be $400,000.
As mentioned earlier, a collateral mortgage can be registered for as much as 125% of the value of your property. This is called the Loan to Value Ratio or LTV. With that in mind, we can now calculate the maximum amount your lender can register.
Property Value × (Max LTV ÷ 100)
$500,000 × 1.25 = $625,000
The maximum amount your lender can register with a collateral mortgage is $625,000.
As your property value appreciates over time, you can borrow up to 80% of its new appraised value from your lender, minus the remaining balance on your mortgage’s principal. This can be done without having to refinance the mortgage.
In this example, let’s assume that the value of your home increased to $550,000 and the remaining balance on your mortgage is $200,000. Here’s how to calculate your available equity.
Increased Property Value × (80 ÷ 100) - Outstanding Mortgage Balance
$550,000 × 0.8 - $200,000 = $240,000
Your available equity would be $240,000.
Most lenders in Canada can supply you with a collateral mortgage. It’s important to note that not all lenders will register a mortgage for more than its original amount, but there are some that may be willing to do so. Be sure to get all of the details in order before you decide to pursue a collateral mortgage.
If you have any questions or concerns about how collateral mortgages work, or whether or not one would be the right mortgage product for you, be sure to consult with your mortgage broker or lender.