What the banks don’t want you to know about collateral charge mortgage
Collateral Mortgage is the mortgage of choice that banks offer to Canadians. Most collateral charge mortgage has at least two components – A HELOC and a fixed rate mortgage. This mortgage allows your bank to readvance additional money should you need it without having to do a refinance your mortgage and pay a lawyer legal fee. Some has only one – a HELOC which can only be 65% of the value of the home when the mortgage is taken out. Some include a car loan(s), credit card(s) and other debt which are either advanced at the beginning of the mortgage or during the term of the mortgage.
Since the inception of the stress test the banks have continued to advance collateral charge mortgage but the readvancement has not been as easy. To get additional funds you will need to reapply and be approved based on credit, income and of course the stress test. In a rising home sales market, the value of your house goes up and there is equity to advance more money. In the current housing market, many borrowers have been turned down for getting additional funds as the equity in their homes is probably less than the registered amount.
Scotia Total Equity Plan better known as S.T.E.P, like the TD Bank Flexline, Royal Bank’s Homeline, CIBC Home Power Plan and CIBC’s Home Power Plan and BMO’s Home Equity Loan Plan all offer a first and second mortgage as a collateral charge mortgage. Under a collateral charge mortgage, the lender typically 125% of the value of the home as a mortgage.
There are some benefits as well as some pitfalls and sadly the pros are highlighted but not the cons. As early as 2013 there was evidence of potential problems for consumers with Collateral Charge mortgage and the then finance minister announced that there was an agreement with eight of the major banks to voluntary disclose general information about collateral charge mortgage September 1, 2014 and in their branches by Nov. 30, 2014.
Of the 5 largest banks in Canada only one has mention of collateral charge mortgage on their website and below is the five-line disclosure.
“Collateral charges: security is provided in favor of “Name of the Bank” (carrying on business as “Nameofthebank”), registered in first position priority on the land and building. The specific details of the mortgage loan are not included in the charge that is registered on the title to your home. A separate credit agreement contains the specific terms of the mortgage loan. This collateral charge may secure other debt besides the mortgage loan”.
A copy of the standard charge term that govern all mortgage consist of about ten pages and the separate agreement for collateral charge mortgage another ten pages. All borrowers sign a document in the bank that they have gotten a copy and that it was explained to them but that’s not usually the case.
Whereas there are some upsides to the there are pitfalls. The Consumer Agency of Canada (FCAC) a federal agency task by the government to protect consumers and inform the about financial products and services website states “a collateral mortgage is a type of mortgage that allows consumers to use their home as security for both a home loan and other borrowing such as a line of credit or car loan”.
The FCAC goes on to say “while many consumers continue to choose a traditional mortgage to secure their home loans, many are increasingly choosing collateral charge mortgages. The impacts of having a collateral charge mortgage may differ from traditional mortgages. For instance, switching between lenders may be more difficult. To make an informed choice, consumers need sufficient information to clearly understand the costs and consequences of collateral charge mortgages relative to traditional mortgages. The Government will require enhanced disclosure, better equipping borrowers to understand these impacts.”
There was an interesting piece done by the Toronto Star and Dustan Woodhouse who is undoubtedly one of Canada’s top mortgage professional Dustan has probably guided more Canadians than any other agent out of the pitfalls of collateral charge mortgage.
Advantages of a collateral charge mortgage
If you are like most borrowers when you are approved for a mortgage by the big 5 banks and some credit unions you go to the branch to sign your mortgage documents and they offer you a credit card, maybe a car loan and a (secured) Line of credit. Canadians fascination with lines of credit is one of the leading causes of household spending $1.79 for every $1.00 they earn on financing debt.
If you later will need to do home renovation, use a line of credit to send your children to school you could have funds available to you so they will usually register about 125% of the value of your house. In other words if you have a property valued at $700,000.00 and you have a mortgage of $400,000.00, they will register a mortgage on your title for $875,000.00. In a rising market that is a great option.
To access the $875,000.00 your lender will have to estimate the value of your house to be about $1,093,750.00 prior to any advance.
The good news is that if you do need to borrow more money at any time you won’t have to refinance your mortgage so the process takes a much shorter time and you will not have to have your house appraised or pay legal fees.
Disadvantages of a collateral charge mortgage
A collateral mortgage cannot be assigned or switched to a new lender or switched at maturity. The only way to get out is to refinance which comes with extra discharge fees. If you have a ScotiaBank STEP mortgage or any of the other similar mortgages and you want to consolidate your HELOC and your fixed rate mortgage (and maybe a car loan and one or two credit cards) even at the same lending institution for any reason. That cannot happen without a refinance, even if you don’t want any additional funds and you are paying down your mortgage. And oh, remember that stress test, you cannot pass go unless you qualify, so if you really need to exit (and its usually for the reasons outlined below) you could be stuck, or worse find yourself in a Power of Sale or Foreclosure because of a $5,000.00 credit card that you are behind in, even if your mortgage is up to date.
Your mortgage, and any other debts you have with that institution is secured by your house. If you are in arrears with your line of credit, credit card or any other loan secured by this mortgage you could be put under power of sale or foreclosure.
That $875,000.00 mortgage registered as a collateral charge mean you could potentially owe your mortgage lender that money even if your mortgage balance is paid down to $35000,000.00. and the value of your house has now risen to $875,000.00 giving you an equity of $5000,000.00. Here’s why:
Your bank could still lend you up to the registered mortgage amount but what if:
- Your credit falls below the line that they will lend?
- Your repayment history has been bad
- You are now a senior and retired with less income to report
- You are laid off or on a disability
- You became self employed and can’t prove your income
- You just started a job and need funds under the 3-month probation period
You wouldn’t qualify for those funds that “available to you” because now you may not be able to qualify even if there were no stress test.
Current market conditions has magnified most borrowers of collateral charge mortgage situation especially if debt balances are high. If the value of your house falls by let’s say 15% as most have over the last two years that $700,000.00 house is now worth about $595,000.00 the $875,00.00 represent a 47% more debt registered on your property than you actually owe.
Can you see a lender lending $875,000.00 on a house that they believe to be worth $595,000.00? If your bank decides not to advance any additional financing, your options are very limited and expensive:
- Refinancing your mortgage and paying a penalt="sunlite mortgage"y
- cashing in investments or RRSP’s
- Transferring or switching to another lender even if the mortgage is up for renewal at the end of the mortgage term would be costly – discharge fees, etc.
- Getting secondary (second mortgage or a private mortgage) and sometimes from finance agencies might prove difficult as on paper it shows you owe more debt
- You might have to resort to payday loans as a last resort.
If you cannot refinance, switch or transfer your mortgage, you will have to stay with your current lender even if a new lender would offer a better term and rate.
A mortgage is a loan that you take out to buy your home but its also an investment and banks are always coming up with ideas (investments) to make a better return. A collateral charge mortgage is one such investment and more and more lenders are using collateral charge mortgage to retain borrowers. If you are in a mortgage you cannot transfer or refinance, your only choice but is stay with your existing lender whether it’s in your best interest or not.
Over the years we have seen the major banks push for a power of sale because a credit card that was included in a collateral charge mortgage was behind in payments. Clearly this mortgage (investment) is not for all borrowers and a Know Your Client Rule (protects borrowers by ensuring any advice they receive, or mortgage products are suitable for them. It also protects advisors by giving them a better idea of the advice, mortgage products and services they can offer each client). With all the risk associated with a mortgage to the borrower and especially the risk associated with collateral charge mortgages the Financial Consumer Agency of Canada requirement that banks should see whether a collateral charge mortgage is suitable for each client is very important.
There still need to be more disclosure from banks about collateral charge mortgage, as borrowers aren’t given much advices by the staff in the bank who have quotas to fill and are therefore not putting the borrowers interest first by explaining the pros and cons. During a financial crisis borrowers sometime learn they have no options as they haven’t prepared for contingencies. Most only find out once they have been approved for a mortgage and realize cant access funds.There are many lenders through the mortgage brokerage channel that offer both collateral charge mortgages and standard charge mortgage and are paid by the banks to advise them. Maybe using an independent mortgage consultant might be more unbiased than a proprietary employee looking out for the interest of the employer.
Have you experienced difficulty getting additional financing with your mortgage? Why?
Devon Jones is a award winning mortgage broker with over 20 years lending experience.
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