Please note I’m not a mortgage broker and don’t recommend any specific type of mortgage.
If you’re a potential home-buyer, no doubt you’ve been sweating and pouring over each detail of securing a mortgage. I guess the same applies if you’re looking to refinance.
Fixed vs variable interest rate? Check. Amortization period? Check. Payment frequency? Check. Pre-payment privileges and mortgage penalty? Check as well.
But do you know what kind of mortgage you have? Conventional or collateral? Yeah, I can hear crickets right now.
Most people don’t give any thoughts to this. I also didn’t look into the matter until I refinanced my mortgage a few years ago.
Rest assured, I’ve got you covered.
In Canada, a conventional mortgage is a loan for up to 80% of a property purchase price, market or appraised value. It means the buyer is putting a 20% down payment. The loan is uninsured, meaning you don’t have to pay any insurance premiums to CMHC or Genworth, saving you a lot of money and interests.
For example, if you buy a $500K property and out 20% down, i.e. $100K, the lender will loan you the remaining $400K. If the appraisal came in at $600K, you could borrow an extra $80K, i.e. 80% of the value of the home.
Conventional mortgages can be of fixed or variable rates, with amortizations up to 30 years and pre-payments options, as well as the applicable penalties and administrative fees.
The lender will register the mortgage with the amount loaned against your property at your province’s Land Title Office.
They can easily be discharged, and even transferred under certain conditions. You don’t necessarily need a lawyer or a notary to do so. The title insurance company can handle this for you. The fee to discharge this type of mortgage is set at $75.00, at the time of writing.
You can also apply for a HELOC or a 2nd mortgage, depending on the assessed value of your property and the equity available. You can obtain these 2 products from a different lender.
However, if your property value increases and you want to take cash out of your existing conventional mortgage, you can’t. You have to refinance, with the applicable paperwork, penalty and legal fees.
If you have a variable interest rate and it increases, your payment will increase accordingly.
If you find yourself under water, financially, you’ll have more time to get your house in order -pun intended-. A conventional mortgage is a loan that is only payable at maturity, or at the end of a term.
Sure, you agreed to make weekly, bi-weekly or monthly payments upon signing; but if you miss a payment or 2, and can make-up for it later on, your lender has no choice but to keep honoring the agreement.
A collateral mortgage is a re-advanceable financial product. It means you can borrow more than the purchase price of your property. Unlike a conventional mortgage, you can borrow-up to 125% of the property assessed value.
Let’s say you buy a $500K property with a 20% down payment -100K-. You need an extra $400K to complete your purchase, just like with a conventional mortgage.
Let’s say that the property is also appraised at $600K. What you could actually borrow is $750 000 minus what you owe on your mortgage. In this case, it would be an extra $125K.
Collateral mortgages also come with fixed or variable rates, offer amortizations up to 30 years and pre-payments options, as well as the applicable penalties and administrative fees.
Rather than being a loan, a collateral mortgage is a promissory note. It means that it’s payable in full and on demand. Lenders aren’t going to demand a full payment just for the sake of it. But if you fall behind your payments, they’ll be be quicker to take action.
There are a few other key differences that you need to be aware of, with collateral mortgages:
- You can borrow more from your mortgage without refinancing: this is the main advantage of a collateral mortgage. Because of the 125% on the assessed value, you can access more of the equity in your home, more easily. However, the maximum amount you can borrow is capped at the amount the lender registered the mortgage for. If it’s $750K, that’s all you can do, even if your property value raises to $1 million.
- Your mortgage payment may remain the same, even with a variable rate: if interests rates increase, it may not be reflected in your payment, if you went with a variable rate. This is both good and not so good. Interests are added to your mortgage and more of your payment is going towards these, instead of equity.
- The interest rate is at the sole discretion of the lender: yes, you’re reading correctly. Lenders can set any rate they want, however they usually stick with the Bank of Canada’s and their competitors’. It wouldn’t be that great for their business otherwise.
- The mortgage isn’t registered at the Land Title Office, but with the lender: this means only the lender can discharge the mortgage, and that it’s not transferrable. You’ll need a lawyer to have it discharged. Your lender will also charge their own fees to do so, well above $75.00.
- The registered amount could give the impression that you owe more than you actually do: let’s say you borrow $500K to buy a property -as per example above-, but the lender registers your mortgage at $750K, it will show as you owing that amount, when it’s not the case. Most lenders will let you determine the amount you want to register the mortgage for. I’d suggest confirming with your lender and being conservative.
- Obtaining a 2nd mortgage is almost impossible: it’s unlikely your lender will allow for a 2nd mortgage to be registered against your property.
- Lender’s HELOC only: Your lender is unlikely to allow for a competitor’s HELOC on your home either. You’ll have no choice but your lender’s product. It may not be the best interest rate.
- Can be used to secure unsecured debts with same lender: if you have a line of credit or a car payment with the same lender, they both could become secured debt against your property. If you discharge the mortgage, you could be asked to pay off the other debts that you have with the lender.
Here was a relatively brief overview and comparison of conventional and collateral mortgages.
Conventional mortgages are way more straightforward, but it doesn’t mean you should forego collateral mortgages entirely. They can be the right mortgage for you, as long as you fully understand what you’re getting into.
Besides, collateral mortgages are here to stay. TD and Tangerine have only been offering this type of mortgage for the last 10 years.