Are You Aware Of What Type of Mortgage You Have?
Countless times when we are dealing with clients who wish to transfer their mortgage or refinance their home, they become very upset and disappointed to find out that their existing mortgage is a “collateral” mortgage.
A collateral mortgage is basically a promissory note or loan agreement secured by the collateral security of a mortgage against your home. Lenders who offer collateral mortgages will typically register the mortgage for a much higher amount than what you are borrowing. Sometimes for the full value of your home and we have often seen the amount registered for as much as 125% of the value.
A collateral mortgage is designed to provide the consumer flexibility with borrowing. Ideally, with a collateral mortgage, you could mix and match your borrowings so that you could access credit without having to re-apply. It can be a great tool, if it’s set up properly and if the consumer is fully aware of the benefits and the pitfalls.
However, most consumers are not aware. Frankly, if your credit facilities are not properly set up at inception, one cannot easily borrow funds, regardless of the registered amount of the collateral mortgage.
Over the last several years, collateral mortgages have become popular with some lenders. Again, they can offer advantages to lenders and borrowers through their flexibility, but they can also contain pitfalls.
First and foremost, know if you are signing up for a collateral mortgage or a conventional mortgage. This is rule number one. Most don’t and find out the hard way.
If you decide a collateral mortgage is right for you, it is necessary for your mortgage broker, your lender and your solicitor to explain what debts are secured. Generally this will be all present and future borrowings. We have seen lenders add loans that are not related to the secured amount.
You must be aware that default under any loan product under the collateral umbrella would be considered a default under the mortgage. To reiterate, it’s not just the funds being advanced on closing, but all other debts under the collateral umbrella.
When paying out a collateral mortgage, many expect the balance to be that of their mortgage, only to find out that any line of credit, credit card or loan is included in the payout and they end up being short on funds for their next closing, investment, etc. Obviously not a nice surprise.
If your collateral mortgage is registered for a higher amount than what you are borrowing, ensure that the facility(s) are in place at closing. There is no point whatsoever in having your home secured for a higher amount that what you have borrowed if you have to go back to the bank and apply to access funds.
For example, if you are purchasing a home for $500,000 and your down payment is $100,000, your borrowing amount is $400,000. You may wish to have this set up as a collateral mortgage so that $300,000 is a regular mortgage and $100,000 is a Line of Credit. If the lender should wish to register for a higher amount, have them approve you for the facility before the mortgage is closed and registered. They likely will not agree to this and will advise you that the higher amount will be available once you pay down your mortgage or home increases in value. However, there is no point in registering the collateral mortgage for the higher amount as you will still have to apply for any additional facility, leaving your home exposed at a higher security amount for no reason in the interim.
Countless times we hear from clients that tell us they “don’t have a mortgage” during our original meeting and consultation. So often, people believe that a secured line of credit is not a mortgage. In fact, many who apply for a secured line of credit are hesitant to proceed at first as they suggest they wanted a secured line of credit and not a mortgage. Finding out your borrowings are part of a mortgage can seriously affect your plans to sell or refinance so it’s important you are aware of how your home and borrowings are secured.
Subsequent borrowings become an issue when you have a collateral mortgage registered against your home. Let’s assume your mortgage balance was $200,000 and you wanted to borrow an additional $50,000 for renovations. You originally paid the home $400,000, but it is now worth $450,000. In your mind, you have plenty of equity to borrow that extra $50,000. However, at time of closing you find out that the original mortgage was in fact a collateral mortgage and it was registered for $425,000. Even though you only owe $200,000, the new lender must consider the total secured amount of $425,000 as your balance and would likely not grant you the new loan as there is not sufficient equity.
In the above scenario, the borrower may then realize he has borrowing capabilities with his existing lender for up to $425,000. However, when he tries to access those funds, he must still go through a qualification process and may or may not be approved, leaving the home exposed at $425,000 of security with only $200,000 of debt.
With all that said, we love the collateral mortgage provided it is set up properly from the onset. It provides you with extreme flexibility of borrowing against your equity and this could have serious benefits to the consumer. However, you must ensure that you know if your mortgage is a collateral or a conventional mortgage. If you decide on a collateral mortgage, ensure it is registered “only” for the amount you can presently borrow. Ensure that your borrowing facilities are set up at closing, not at a later date and that you have full access to the amount registered.
VERICO The Financial Forum Ltd.
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