When you’re considering a new mortgage, whether it’s to buy a new home, refinance to tap into your home’s equity or to simply switch lenders, it’s important to know about your options.
Most homeowners know the difference between fixed and variable mortgages, but far fewer people understand that many lenders offer collateral mortgages as well as conventional mortgages.
Collateral mortgages are more of a mystery to many homeowners — in fact some people may not even realize that they have one. We’re here to shed light on this common, but little-understood mortgage option.
How a collateral mortgage works
A conventional mortgage places a mortgage charge on your home and is registered with the local land title office, whereas a collateral mortgage is registered with the financial institution that is lending you the money (the lender). Because a conventional mortgage is registered with the title office, you can change lenders, transfer between lenders or discharge from the lender. A collateral mortgage is not registered with the local registry office but with the lender, therefore you can only re-register it with, or discharge it from, the original lender: it cannot be transferred to another lender. This is a key difference we will discuss in more detail later.
The idea behind a collateral mortgage is to provide greater flexibility and to allow homeowners to access the equity in their home more easily. Besides providing you with the money you need to buy your home or renew your mortgage, a collateral mortgage can also provide you with access to some of your home’s equity, which then becomes a source of funds.
Some lenders will register the collateral mortgage at the full value of the home or even 125% of the home’s value. The mortgage you pay will still be the amount you need to buy your home or renew your mortgage, but some of the extra money will be available to you, typically through a line of credit. In some cases, as your home’s value rises, the amount of money available to you will also increase.
This will allow you to access more money from your home’s equity, without having to apply for a line of credit or go through the time and expense of refinancing your mortgage. It’s an extremely convenient and useful mortgage for those homeowners who think they will need extra money during the term of their mortgage contract.
A small number of lenders only deal in collateral mortgages, while many offer both conventional and collateral mortgages.
An example of a collateral mortgage
Let’s say your home is worth $500,000 and you owe $300,000 on your mortgage.
The difference — $200,000 — is what you have in equity.
Your lender registers the collateral mortgage for $625,000 (or 125% of your home’s current value).
In five years, your home’s value increases to $650,000 and the balance on your mortgage has dropped to $230,000.
You now have $420,000 in equity in your home.
Most lenders will lend up to 80% of your home’s value, minus your outstanding mortgage:
[$650,000 x 80%] = $520,000 - $230,000 = $290,000
You could now access $290,000 of your equity for any purpose, without having to refinance your property.
$290,000 + $230,000 = $520,000, still below $625,000, which is the principal amount of the collateral mortgage and the most you would be able to borrow.
Conventional versus collateral mortgage
We mentioned earlier that a collateral mortgage cannot be transferred to another lender, unlike a conventional mortgage. With a conventional mortgage, when the time comes to renew (typically when the five-year term is up) you can switch mortgage lenders with minimal fuss and nominal or zero cost.
If you have a collateral mortgage and want to switch lenders, you would have to discharge the mortgage from your previous lender, then register it with your new lender, all of which would require you to pay legal fees.
Also, with a conventional mortgage, you can take out a line of credit secured on your home with a different lender (which normally means much lower interest rates than personal lines of credit). If you have a collateral mortgage, this would not be possible.