Dreaming of a mortgage, this couple is

Understanding collateral mortgages

Are you in the real estate market for a home? Buying a home can be a busy time to say the least. Besides keeping up with all your regular weekly errands, you’ll also need to find time to view properties. After weeks or months of house hunting, once you’ve found a home you’d like to call your own and successfully made an offer, you'll want to celebrate. While there’s nothing wrong with celebrating with a glass of champagne, treating your mortgage as an afterthought is a big mistake. It’s the biggest debt of your lifetime after all.

When it comes to shopping for a mortgage, many of us start at our local bank branch. While there’s nothing wrong with that, your local bank branch shouldn’t be your only stop. Mortgage rate comparison websites like the one you’re on make it easier than ever to compare mortgage rates. Many people shop based solely on finding the lowest mortgage rate. The lowest mortgage rate may be the best mortgage, but there’s no guarantee of it. There are other things to consider, such as whether the mortgage has a collateral charge.

What is a Collateral Mortgage?

A collateral mortgage may sound a lot like a conventional mortgage (since both start with the letter “C”), but they are two separate mortgage products. Collateral mortgages are a mainstream mortgage product offered by most of the big banks, including TD Bank and Tangerine. Some lenders exclusively offer them.

When it comes to choosing mortgages, it’s important to understand the difference between a standard and collateral charge. A conventional mortgage is when you just borrow the mortgage amount required to purchase the property. As such, it comes with a standard charge. For example, let’s say you’re buying a home for $800,000 with a 20 percent down payment of $160,000. In this example, you’ll need a mortgage of $640,000. Seems pretty simple.

With a collateral mortgage, it’s slightly different. A collateral charge of up to 1.25 times your home’s value is registered with your mortgage. In the same example, your lender could register a charge up to $1,000,000 ($800,000 X 1.25). 

Why Choose a Collateral Mortgage?

With  home prices rising rapidly in markets like Toronto and Vancouver, many homeowners are choosing to tap into their homes with Home Equity Lines of Credit (HELOCs). When you have a collateral mortgage, it makes it easier and less costly to take out a HELOC. With a HELOC, you can borrow money at a low interest rate to undertake a home renovation or purchase a rental property.

While that may sound great, collateral mortgages do have some negatives. When your mortgage comes up for renewal, you’ll want to shop around to see if you can find a better mortgage rate elsewhere. This is made more challenging with a collateral mortgage. Since your mortgage has a line of credit attached to it, it makes it more costly to move to another mortgage lender. If you decide to break your mortgage, not only could you face a costly mortgage penalty, you’ll have to pay legal fees as well due to your collateral mortgage.

Keep in mind when your collateral mortgage comes up for renewal, your lender probably won’t offer its best rate to you. That’s because they’re aware of the added cost of switching to another lender. The bottom line is collateral mortgages can be great if you plan to take out a HELOC, but everyone else is probably better off choosing a conventional mortgage with a standard charge.