Collateral mortgages versus conventional mortgages

BY PAM PIKKERT

Ok. Mortgages can be seriously confusing.

Variable, fixed, closed, open, and on and on. As though that wasn’t enough? We are going to learn about something new that you really should be aware of so that you can make an informed decision.

Today my mortgage minions we will learn about collateral mortgages. So what in the heck is a collateral mortgage and how is it different from the conventional mortgage? We have to delve a little deeper into the ins and outs of a mortgage to get an answer to this question. Basically, when you get a mortgage, the lending institution places a charge against the title of the property. It is for the amount that you owe them. That makes sense. You have agreed to pay them back and so all they are doing is protecting their interests until you do so.

So how are the two different you ask? With a collateral mortgage you can choose to go up to 125% of your home’s value while the conventional is registered at just the amount you currently owe.

Let’s break it down so you can see how the numbers would look.

Conventional mortgage from Lender X: You borrow $300,000 so on the title of the property it will say you owe the lender $300,000.

Collateral mortgage from Lender X: You borrow $300,000 but now on the title of the property it says you owe the lender $375,000.

The Collateral mortgage is neither good nor bad really. It should be viewed as a tool in your financial tool box. However as with everything there are pros and cons. So let’s look at both sides.

The benefits: The primary benefit of the collateral mortgage is that you are set up for future borrowing needs.

For example, you decide to finish the basement of your house. The lender is able to put a line of credit in place for you without you incurring additional legal fees.

An important note is that you will have to re-qualify for the additional funds. The lender will pull credit, may require an appraisal, proof of employment and so on and so forth.

The cons: You are basically entering into an all indebtedness mortgage, which brings any other debts to that lender under the umbrella of the registered security. Your car loan or credit card will now be attached to the mortgage and if you stop making payments on those it could ultimately result in foreclosure.

Keep in mind that should you tie all your debts together and then choose to sell your home that all debts tied to the mortgage will be paid out upon the sale. This could eat up a large portion of your existing equity which could decrease the down payment available for your next home.

The collateral mortgage can also make it harder to move to a new lender at renewal which could mean you end up in a higher interest rate as you have to remain with the current lender.

If you do fall behind on your mortgage payments, the collateral mortgage provides the right for the lender to potentially start charging a higher rate of interest if a higher rate is written in compared to what you are initially paying. Because the lender has such a strong securing position, they can justify the increase to cover a higher risk of repayment default while not really having any real risk of potential loss. The end result is even if you get back on track, you now have a higher interest rate to pay, which can lead to higher prepayment penalties if you try to move your mortgage to another lender.

So what now?

What can you do to safely navigate these murky waters? Don’t have all your banking, credit cards and small loans with the same institution. Perhaps consider even having your mortgage with a completely separate lender to avoid the possibility of tying your debts together. Or just be aware of what you are signing.

Should I consider a collateral mortgage or just stick to a conventional mortgage?

This is one of those depends answers. Currently in the market place, some lenders are providing the customer with an option of taking a conventional mortgage or a collateral mortgage.

However, this is not true with all lenders and this fall, some mortgage providers are talking about only offering a collateral mortgage option.

Because banks offer a fast closing process which tends to be cheaper than going through your own lawyer, many borrowers are going to sign off on a collateral mortgage without really understanding the pros and cons.

So the key here is understanding what you’re signing up for.

If the benefits of a collateral mortgage fit your needs, then there is certainly nothing wrong with accepting this type of mortgage offer.

But if the terms and conditions are going to be too restrictive for your future financial planning and cash flow management requirements, then a conventional mortgage may make more sense.

Before signing off on any mortgage offering, make sure you are getting independent legal advice if you’re not completely sure as to how all the terms and conditions of a mortgage work.

That way you can make an informed decision and have less chance of regretting it at some future date.

Pam Pikkert is a mortgage broker with Dominion Lending Centres – Regional Mortgage Group in Red Deer.

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