What is a collateral mortgage?
A collateral mortgage is a different type of lien on your property than a conventional or standard mortgage. While collateral charges have always been used for home equity lines of credit (HELOCs), it is now being used by TD and ING on ALL of their mortgages. TD began registering all mortgages as collateral charges as of October 18, 2010 and ING began the same on December 10, 2011. This can have a major negative impact on clients of these lenders, often without them realizing it.
A conventional mortgage is simply a loan secured by a property. The loan amount, payment, rate, term, and amortization are all clearly established and registered with Alberta Land Titles. Other Canadian lenders will accept "transfers" of conventional mortgages from one lender to another with little to no cost to you.
The structure of a collateral mortgage is very different from a conventional mortgage, allowing it to be registered for a value greater than the current property value. Lenders register these charges on title for as much as 125% of the purchase price, assuming equity will increase with market values over time. They hope you will later qualify to draw upon that equity. In addition, the interest rate registered can be as high as prime plus 10% giving the lender flexibility to increase your rate over the life of the loan.
A collateral charge is re-advanceable which means the lender can lend you more money during your term without you needing to refinance and pay lawyer fees. The other major difference, and source of the pitfalls, is that a collateral charge is non-transferable and cannot be assigned or switched to a new lender or a new property like a regular mortgage.
Why lenders love them and consumers don't
While collateral mortgages can save legal fees for clients who refinance, there are major considerations to be aware of:
Barriers to Moving Your Mortgage - Generally you can move your mortgage to another lender at the time of your renewal with little cost. With a collateral charge you would have to pay legal fees to switch lenders because the charge or lien on your property has to be fully discharged and re-registered under the new lender.
Less Competitive Rates at Renewal - Lenders like TD and ING know it would cost their clients more to move lenders. They have no reason to offer you competitive rates at renewal. This type of mortgage charge marries you to your lender.
Lender Can Access Other Assets - Canadian law allows a lender to seize equity to cover other debt their client holds with the same lender. This does not apply to the clearly defined terms and contract of a conventionally registered mortgage but does apply to collateral mortgages. If you default on a collateral mortgage and have other assets with the same lender (ex. savings account, investment account, etc.), the lender can pull money from these other assets to cover the default without your approval.
Interest Rate and Payments Can Change - Collateral charges allow lenders to change the interest rate and/or loan amount after the original closing and property registration. If you miss a payment or add money to your loan amount, the lender can change their terms, including an increase in interest rate for the life of your loan.
Lack of Portability - A collateral charge is property specific. If you move to another property you will not be able to port this mortgage. You will have to pay pre-payment penalties to have it discharged and you will have to apply for a new mortgage (at current market interest rates) and pay legal fees on the new mortgage.
The lenders' argument
TD and ING claim that they have changed to collateral charges as a response to their clients' needs. Now, when their clients refinance they save legal costs when they apply and qualify to increase their loan amount. These lenders also claim that mortgage holders who do not need to refinance are not impacted by the barriers to switch lenders as statistics show that most renew with their existing lender anyway.
What you should ask yourself before agreeing to a collateral mortgage:
1. Are you comfortable tying yourself to this lender to the end of your amortization - for 20, 25 years?
2. If you want to move your mortgage down the road, are you prepared to pay hefty legal fees?
3. What is more important to you - having access to your home equity as a source of credit, or paying off your mortgage?