What is a collateral mortgage?

With so many types of mortgages to choose from, it’s always a good idea to do your research and to have a basic understanding of all of them. Some types of mortgages are more common than others. A collateral mortgage isn’t always widely discussed, but some investors have this type of mortgage without even realizing it.

We’ll be comparing collateral mortgages with conventional mortgages, covering the pros and cons, helping you choose which one is a better fit for you, and going over some other important information.

Right off the bat, let’s clear the air. Many articles have been published over the years that have made consumers terrified of collateral mortgages. Some clients have rejected them outright, even with favourable terms – many people in the mortgage industry will be able to attest to this with firsthand experience. Collateral mortgages don’t have the best reputation, to say the least.

Does that mean they are never a good choice? Does that mean they are completely without merit and should be avoided at all costs, all the time? Absolutely not. There are situations where a collateral mortgage can make sense, especially for people who are willing to dig in a little deeper and to really understand this product. Having said that, the criticism of them didn’t come from out of thin air – there are valid and legitimate criticisms of this type of mortgage product, too.

Your best bet is to do your research, gain an understanding of the differences and the pros and cons, and then make an informed decision. Don’t be afraid to ask questions and to get clarifications if anything doesn’t seem to add up, and always make sure that you understand the details before signing anything.

Alright, with that out of the way, let’s dig in and talk about the differences between collateral and a conventional mortgage.

What are the basics of mortgage charge accounts?

The investment property you purchase with a mortgage is used to secure the loan, the amount of the loan is a charge against the real estate. This can be carried out as a collateral charge, or a conventional charge. A conventional charge meets the amount you need to borrow to purchase the investment property, a collateral charge is for a greater amount than what you need to pay for the property. This charge is registered with the appropriate government office in your city or town.

What’s the difference between a collateral mortgage versus a conventional mortgage loan?

To put it as simply as possible, a conventional mortgage charge is when the exact amount of the loan is what is registered against the investment property as a liability. If you take out a mortgage and need to borrow $375,000 to purchase your investment property, that is the amount that is registered as a liability. This doesn’t necessarily mean you’re borrowing $375,000 to purchase an investment property worth $375,000 because there is still a down payment involved.

When you take out a collateral mortgage, the charge can be higher than that. It could be $425,000, $475,000, and so on – or it could simply be the total value of the investment property, which is still greater than the total amount you need since you’ll have made a down payment already. This leaves the door open to access these additional funds down the road, for example, if you need to do repairs or you decide to renovate your investment property.

The extra collateral can make it more difficult to switch lenders, which favours the banks. Also, if there’s an extra $50,000 or $100,000 sitting in the collateral mortgage, you may not have built up as much equity as you think, should you want to refinance or take out a line of credit down the road.

What is a conventional mortgage?

In other words, a conventional mortgage is when you’re lent the amount of money that you need to purchase the property in question. If the investment property costs $400,000, and you make a 25% down payment, your conventional mortgage will be for the amount of $300,000, because that’s how many additional funds you need to purchase the real estate.

What is a collateral mortgage?

A collateral mortgage, on the other hand, is when you’re given a loan for a higher amount. For example, a 100% collateral mortgage would be, if in the above scenario, you are buying in investment property for $400,000 and you make a 25% down payment, but the charge amount of your mortgage is still $400,000 (instead of the $300,000 mentioned above, which is the price of the property minus the down payment – where the amount of the mortgage is used to pay the difference between the price and the down payment).

You won’t necessarily have access to all of the $400,000 at once, you’ll receive the amount you need for the property and the rest will be available should you need it down the road, but you’ll still need to apply for it and be approved in order to access it.

Which one is the better choice?

Some banks have begun to only offer collateral mortgages, whereas others offer a choice. If the bank you want to deal with only offers collateral mortgages, and you want a conventional mortgage, you’ll have to either compromise and accept a collateral mortgage or to choose a different bank. People with existing mortgages won’t have to change to collateral if their bank switches, but new mortgages at these banks will only be signed with collateral charges.

Asking which one is better also depends on which point of view you’re coming from. All things being equal, you’re probably better off having more flexibility to switch lenders when your mortgage term is up, or at least having more leverage in the negotiations. When your hands are tied by a mortgage that is harder to switch to another lender, you lose leverage, which ultimately can translate into losing out on the possibility of a better rate. If your lender knows you can easily take your business elsewhere, it stands to reason that you’ll have a better shot at getting a more favourable rate from them.

From a bank or other mortgage lender’s point of view, collateral mortgages are great, they like them a lot. Some banks are pushing these heavily, or just flat-out not offering conventional charge mortgages anymore. That tells you everything you need to know. If the banks and lenders heavily favour one type of product over another, that is almost universally because it benefits them. As to which type of mortgage charge is better, the banks would say “collateral”, and it does have certain benefits for borrowers in certain situations, but as you’ll see, the cons tend to outnumber the pros.

What are the pros and cons of a collateral mortgage?

Let’s go over the pros and cons of a collateral mortgage. Not all of these will apply to everybody in every situation, but they’ll give you an idea of what to expect, what you’re getting yourself into, and what you should keep in mind if you’re considering a collateral charge mortgage.

Pros

A collateral mortgage gives you the opportunity to secure additional money against your investment property without having to take out a second mortgage. Granted, you will still need to apply and be approved for these additional funds, but it’s an opportunity to access relatively low-interest capital compared to other options.

If your property value is increasing as real estate markets surge, you’ll have access to additional funds without the need to refinance. As such, it’s easier to borrow more money from your lender.

You’re able to borrow additional money without the normal costs that come with refinancing your mortgage as the term comes up, which includes all of the same legal and other fees that you had to pay when you initially signed the mortgage.

Cons

When your mortgage term is up, you might decide to take your mortgage to a different lender. This is a very straightforward process with a conventional mortgage, but it can be costlier and more complex if you have a collateral mortgage. Some argue this isn’t the case if you have a great credit history, as lenders will still want to compete for your business, but that’s just looking at things through the lens of an ideal situation – and that’s not always the case.

If your mortgage is registered at a higher amount than the value of the investment property, for example, if it was registered at 125%, that becomes a significantly higher risk for the new lender to take on if you’re trying to switch lenders.

Having your mortgage registered at a higher amount doesn’t necessarily mean you’ll instantly have access to those extra funds. The lender can register the loan at a higher amount, but they will still need to approve you before you can access it. You’ll still need to apply to access those extra funds, to get approved, and so on and so forth.

When your existing mortgage lender has you locked-in and they know it will be difficult for you to switch to another lender, they have a lot more power over the negotiation process when it comes time to renew your mortgage at the end of a term.

What are some other things to keep in mind?

Collateral mortgages will always be described as exactly that in your mortgage documents. A conventional charge mortgage could also be referred to as non-collateral mortgages, traditional mortgages, standard charges, traditional residential mortgages, or retail mortgages.

Most banks offer collateral mortgages, but it’s not all that common (yet) for banks to only offer this type of mortgage. Granted, there is enough competition that any bank that holds out is going to be at a competitive advantage unless a time comes where all banks are making the switch to only offering this one product.

Mortgage rates can vary for a number of reasons, and the larger your mortgage is, the more interest you’ll end up paying in the long run. Having said that, if you don’t tap into the extra charge on a collateral charge mortgage, you won’t be paying interest on it. If you do end up accessing that money to fix up your investment property or for another purpose, you’ll realize that it comes at a lower cost than borrowing from credit cards.

Collateral charges work similar to a line of credit, and they offer lower rates than borrowing from credit cards. Still, you should be just as disciplined with this spending, because if you aren’t able to meet the obligations of your mortgage, you risk losing your investment property.

What can I use as collateral for a mortgage?

Don’t mistake a collateral mortgage for the types of loans that you can take out using collateral, it’s not the same thing. A collateral mortgage is not a type of mortgage where you can use various possessions as collateral, this is a misunderstanding. Loans with collateral are secured loans, and a mortgage is a type of secured loan because it is secured against the property itself. Things that can be used as collateral in loans include machinery and equipment for a business, cash accounts, insurance policies, investments, automobiles, valuables, and collectives – but these are used for smaller and different types of loans, not for mortgages.

If you’re taking out a second mortgage, your equity in the investment property is used as collateral, and with car loans, the car itself is used as collateral and that’s why it can be repossessed if you fail to make your payments.

What are the next steps?

Before signing any mortgage, you should make sure you’re very comfortable with your understanding of the terms, the rates, the rules, and any additional fine print that could dictate your ability to repay. Take off your rose-tinted glasses and imagine the worst-case scenario, not just the best-case scenarios in which nothing goes wrong or you never miss a payment – sometimes life happens and it’s good to be prepared!

Beyond that, make sure you thoroughly understand the implications of things like collateral charges vs conventional charges, because the details might not matter to you when you’re eager to get a mortgage and to buy your first investment property, but these types of things can matter a great deal later on.

Mortgage loans can be confusing, it’s a lot more complex than something simple like a credit card, but mortgage loans are essential if you want to own a property (unless you have a huge sum of cash at the ready). Now you have a better understanding of the question “What is a collateral mortgage?” and you’re one step closer to securing the property of your dreams!