Everyone knows what a mortgage is. And most people know the difference between a variable rate and a fixed rate. In recent years, a new financial product has been created: the collateral mortgage. It is therefore important to know what it is and to be well informed when you are ready to buy your home.
How does a collateral mortgage work?
First, a conventional mortgage issues a mortgage charge on your home that is registered with the local land title office. A collateral mortgage registers the debt with the financial institution that is lending you the money. With a regular mortgage, you have the freedom to change lenders without selling. In fact, you can transfer the mortgage along the way and obtain a discharge from the lender. However, in the case of a collateral mortgage, which is registered with your lender and not the land titles office, you can only re-register it with the original lender or have it discharged. In other words, you cannot transfer your mortgage elsewhere.
This financial product was created to provide homeowners with greater flexibility to access the equity in their homes. A collateral mortgage not only provides you with the money to purchase a home, or renew an existing mortgage, but also allows you to use some of the equity in your home. So, your home (its equity) becomes a source of funds.
In general, the lender will record the full value of the house, but others will even go up to 125% of that value. The amount needed to purchase the home will be the amount of the collateral mortgage, a portion of which will be accessible through a line of credit. In some cases, once your home has appreciated in value, you will have access to even more.
This way, you will have more money available to you through the equity in your home but without going through the long and complicated process of re-mortgaging or applying for a line of credit. The collateral mortgage can be a very useful tool if you think you may need funds during the term of your mortgage.
Exemple
Let’s take the case of a house valued at $500,000 and a mortgage balance of $300,000. The difference of $200,000 is the equity in the house.
Then the lender records the mortgage at 125% of the value, so $625,000.
In 5 years your home will be valued at $625,000 but your mortgage will have decreased to $230,000. The equity becomes $395,000 ($625,000 – $230,000).
Creditors will not lend more than 80% of the value of the property. So $625,000 x 80% = $500,000.
$500,000 – $230,000 (mortgage amount) = $270,000 which you can use for renovations for example, without having to refinance the entire property.
Difference between collateral and conventional mortgages
With a conventional mortgage, when your loan matures 5 years later, you can change lenders effortlessly and inexpensively. At the same time, it gives you the opportunity to go shopping for a better interest rate!
Conversely, with a collateral mortgage, you cannot change creditors as easily. You will have to obtain a discharge from your lender and register the mortgage with your new creditor. There are also legal fees associated with this process.
Finally, with a conventional mortgage you can get a home equity line of credit at a much lower interest rate than a personal line of credit or personal loan! With a collateral mortgage you don’t have this option.
Pros of a collateral mortgage
- If you want to make emergency repairs, buy a vehicle, consolidate your debts, whatever, you have access to your funds quickly. The money is liquid.
- Over time, the equity in your home and your accessible funds will grow
- You have no fees for the amount available and growing
- The interest rate is much lower than a credit card or personal loan
Cons
- If you want to change financial institutions, you will have to pay a fee.
- It’s harder to change lenders than with a conventional mortgage
- It is impossible to have a home equity line of credit with another financial institution
- Is the collateral mortgage the righ option for you?
Clearly this financial product is very effective. Certainly, the collateral mortgage is very appealing to homeowners who want to access the liquidity of their home equity. It’s a lot of money and it can be used without justification to anyone.
Think about it…..by doing renovations, you will not only increase the value of your home, but also its equity!