When it comes to understanding mortgages, most savvy home buyers are familiar with a few common elements: the all-important mortgage rate, whether to go fixed or variable, monthly vs. bi-weekly vs. accelerated bi-weekly payments, and the length of the amortization period.
But there’s one option that has, thus far, largely slipped under the public’s radar: the choice between a conventional and a collateral mortgage. It's an important difference to be aware of: the implications of making the wrong choice could be very costly.
Understanding mortgage charge accounts
Whenever you take out or renew a mortgage, you use the house itself to secure the loan. If you default on the payments, the bank can then seek legal means to take over and ultimately sell the property to recoup its investment. This is referred to as a “charge” against the property.
There are two types of charges that can be applied: a “conventional charge” or a “collateral charge”. A conventional charge loan is registered in the precise amount of the mortgage loan, meaning your bank is lending you enough for your home purchase and nothing more.
With a collateral charge mortgage, however, the loan may be registered for an amount higher than what you need for your mortgage -- as much as 125% of the total. For example, the bank might register a $300,000 charge on a $250,000 mortgage loan.
The benefits of a collateral charge mortgage
One potential advantage of the latter is that if you decide you need some additional financing, say, to undertake some renovations after you move in, your bank could lend you the difference between the loan and the charge, provided you qualify. With a conventional mortgage, you’d most-likely register a second mortgage – and incur the legal and administrative costs for doing so – to access additional funds.
Beware collateral damage
So what’s the problem with having access to extra money? For one, just because your mortgage is registered as higher than the actual amount lent, there’s no guarantee your financial institution will hand that over to you. You still have to go through the qualification process – application, credit checks, and so on.
The bigger risk is that with a collateral mortgage, you may lose the ability to renew with a different lender for a better rate at the end of your term. To earn your business, a new bank would essentially have to take over your mortgage from the one you first dealt with. But the bank that placed the initial charge on your mortgage would still have the rights to 125% of your home’s value, making your mortgage a risky investment. In short, most banks will not step in to take over a collateral mortgage.
And, as many other mortgage brokers and other industry experts have already commented on, what incentive does your existing bank have to offer you favourable renewal terms when they’ve already got you more or less locked in?
Addressing the information gap
The fact that many mortgage customers aren't aware of the implications of collateral mortgages -- or that they even have one -- is being addressed by the Ministry of Finance. Minister Joe Oliver has tasked Canada's banks with providing greater transparency and information for consumers. Lenders began rolling out the additional information mid-September in the form of in-branch counselling, pamphlets and online.
Which banks have collateral mortgages?
TD Canada Trust recently – and rather quietly – switched all of their new mortgages over to collateral products. (Clients with existing non-collateral mortgages can keep them as such on renewal.)
Tangerine, the online-only bank formerly known as ING Canada, has also opted to offer only collateral mortgages.
Not sure which you have? According to the Canadian Bankers Association, a collateral charge mortgage will always be referred to as such in the financing documents. Conventional charge mortgages may also be called standard charge, non-collateral charge, traditional charge, traditional residential mortgage, residential mortgage, deed of hypothecary loan (in Quebec), and a retail mortgage.