Collateral vs Conventional Mortgages

By the time many borrowers learn the differences between collateral charge and conventional charge mortgages, it’s too late to do anything about it. And they simply have to live with the consequences, which may come in the form of higher legal fees down the road and other hassles.

Let’s walk through the pros and cons of collateral and conventional mortgages by exploring three scenarios. Each scenario assumes the borrower has an existing mortgage and wants to make a change.

Scenario 1

To take advantage of a lower interest rate at renewal, a borrower decides to switch their mortgage to another lending institution.

a) Collateral charge is more advantageous to the borrower
b) Conventional charge is more advantageous

When switching lenders b) Conventional charge is more advantageous to the borrower.

When a mortgage lien is registered as conventional charge, the borrower can switch to another lender without being hit by higher legal fees resulting from the switch.

On the other hand, if the mortgage is registered as a collateral charge, most banks will simply not allow a switch due to mortgage terms. The mortgage debt will need to be discharged and a new mortgage established with the new lender. The discharge and new mortgage setup usually results in higher legal fees to the borrower.

Scenario 2

To finance a home renovation, a borrower takes advantage of higher real estate prices by dipping into the equity built up in her home.

a) Collateral charge is more advantageous to the borrower
b) Conventional charge is more advantageous

When adding to an existing mortgage, a) Collateral charge is more advantageous to the borrower.

Collateral charge mortgages are readvanceable, which means that there is a built-in option for the lender to advance additional funds to the borrower to finance home renovations or other investments in the future providing the borrower qualifies. When registering a collateral charge, many banks register 100% to 125%, even if the mortgage amount is much lower.

Mortgage amount: $300,000

Appraised value of property: $600,000

Collateral charge: registered at 100%. Lien on the property equals $600,000

In the above example, the client borrows $300,000. However, the lender registers a lien for $600,000 against the property with the Personal Property Security Act of Canada. If the lender wants to borrow an additional $75,000 for a home renovation, the funds can be granted with minimal paperwork. However, always read the fine print as some lenders may still require the borrower to re-qualify.

On the other hand, with a conventional charge mortgage, the lien registered matches the mortgage amount loaned. Borrowing additional funds secured on the same property will require a new mortgage application and approval plus administrative costs.

Scenario 3

An investor seeks a second mortgage on an existing property to finance a new investment.

a) Collateral charge is more advantageous to the investor
b) Conventional charge is more advantageous

In general, b) Conventional charge is more advantageous to investors. investors will want to avoid collateral mortgages if they want the flexibility to transfer the mortgage without additional legal fees or to secure funds via a second mortgage on the property.

As for the legal fees involved for switching lenders once your term is due, some lenders may cover part or all the costs involved with conventional charge transfers. Just ask your broker!

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Susan Williams is a mortgage agent in Toronto with Mortgage Architects. For help you with all your mortgage and refinancing needs, email her at susan.williams@mortgagearchitects.ca.

Creative Solutions: the Vendor Take-Back Loan

Here's a cautionary real estate tale that involves a condo corporation with low reserve funds, a firm purchase offer with no financing conditions and a creative vendor take-back (VTB) solution that may have saved the deal.

In this case, the buyer fell in love with the condo and chose to fend off a competing offer by going in firm without a financing condition. His deposit was submitted and the offer was accepted. Unfortunately, the buyer needed an insured mortgage, but quickly learned that CMHC and Genworth wouldn't insure any condos in that building due to reserve fund issues.

To save the deal, the vendor put forward a vendor take-back mortgage solution whereby the seller offered to loan the buyer 10% of the purchase price in order to bring the downpayment to 20% and remove mortgage insurance from the equation. For the VTB to work, the following would be required:

• The seller had to own the property outright
  
• The buyer would have to secure a conventional mortgage of 80% of the purchase price from a financial institution amenable to these arrangements or through a private lender. The VTB would be registered against the property but would be treated as a second mortgage.
  
• Through lawyers, both VTB parties agree on an interest rate (usually higher than the going rate) and terms for the loan. In many cases, there are no penalties for paying off the mortgage early.

Vendor Take-Backs Have Built-in Risks The risks of getting involved in a VTB mortgage may outweigh the benefits. There is risk the borrower may default on the loan. There is risk of having to pay back the borrowed funds before expected in the case of death. The legal agreement needs to cover all your bases. A wise borrow will work with a mortgage professional to consider the many alternatives to a VTB, including the following:

• Find a co-signer
  
• Find a guarantor who will guarantee that payments are made but have no claim on the property. Some lenders will not permit guarantors.
  
• Invest the time and energy to rebuild your credit
  
• Build a larger down payment from savings or borrow from family
  
• If traditional mortgage funding is not an option, a private lender may be the answer

Talk to a mortgage professional to find a solution that works for you.

In the cautionary tale above, the VTB wasn't entertained as a viable option. The buyer did not want a loan from a seller who did not have the integrity to disclose that the building had issues and financing would likely be a problem. Legal action is underway to end the deal and return the deposit. His next deal will involve more due diligence and a financing condition.

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Susan Williams is a mortgage agent in Toronto with Mortgage Architects. For help you with all your mortgage and refinancing needs, email her at susan.williams@mortgagearchitects.ca.

Quick Tips: Minding Your Credit

Canadians fall into two broad camps: those with good credit scores and those with scores below 680.

Those with sub-680 scores who are looking to buy a home either require a co-signer with good credit or a solid plan to lift their credit score above the magic 680 mark. Some lenders will accept lower credit scores, but that leniency is often paired with higher interest charges and/or upfront fees.

Poor credit scores often involve job loss, business failures, poor investments, poor health, divorce, easy access to credit cards and eventual bill payment neglect, all resulting in stress and the need for retaking control of personal finances.

For Generation Z and other Canadians new to credit, obtaining a first loan or credit card effectively means their every action and move in the credit market is being scrutinized. They enter the credit game where positive behaviour (paying bills on time and in full) is rewarded and negative behaviour (neglecting to pay minimums, delaying payments) puts the borrower on a path that may lead to future credit privileges being rescinded.

But there is good news: A sustained series of positive actions in time can restore credit scores to healthy levels. Here’s how the credit system works, how to maintain a high score and how to lift a low score higher.

High Score, Low Stress

Credit scores are assigned based on “predictive analytics,” a data science technique that mixes data mining, artificial intelligence, statistics and other types of analysis to predict behaviour.

The two major credit report providers in Canada are Equifax and TransUnion. Equifax Beacon Scores range from 300 to 900 (https://www.equifax.ca) with higher scores being more desirable. TransUnion’s Empirica Scores go as high as 850+. Lenders generally use a borrower’s credit history, FICO score (http://www.fico.com) and other information to calculate a credit score.

Here are some of the major determinants of a borrower’s credit score, with potential weightings:

1. Payment History (35%) If you are making your obligatory payments on time, excellent. If you have missed a payment, how long did it take for you to eventually pay? Thirty, 60, 90, 120 days or more? The longer a payment remains in arrears, the more detrimental the impact. Get back on track as soon as possible.
   
   
2. Credit Utilization (30%) Experts advise that you use no more than 30 percent of your available credit. On a credit card with a limit of $5,000, as a rule try keep the monthly balance below $1,500. That said, lenders need to see that you have a track record of taking on and paying off debt. Paying off the balance on your credit card or line of credit will strengthen your score as will a track record of on-time consistent mortgage payments.
   
   
3. New and Existing Credit (25%) Your account history can be used to predict future credit behaviour. Once you start applying for new credit, such as a mortgage loan, the mortgage agent will need your authorization to pull a credit report. The credit report request is considered a hard inquiry, which temporarily lowers your credit score. Seeking other types of credit, say a car loan at the same time will further lower your score. Being hungry for credit will work against you. However, credit report providers understand that when seeking a mortgage you may make several inquiries within a 30-day period. Those inquiries are considered one hard inquiry (https://www.fico.ca). It doesn’t have the negative impact that seeking diverse types of credit at the same time has on your score.
   
   
4. Type of Credit (10%) Having different types of credit can be positive. Having a car loan, mortgage and revolving line of credit -- if consistently paid on time -- enhances your credit score.

Improving Your Score

• If you have a credit score that is lower than 680, start with setting up automatic bill payments or pay your bills a few days before they are due to ensure they are received by due dates.
  
• Pay off credit card balances every month. If you can’t afford to pay down more than the minimum payment, consider getting a personal loan or using a credit line to pay off card balances. One or two credit cards is all most of us need.
  
• If you are struggling with bill payments, consider credit counselling or refinancing your home to consolidate debt.
  
• If you had the unfortunate circumstance of filing for a first bankruptcy, it will stay on your Equifax report for 6 years from the date of discharge and on a TransUnion report for 7 years in Ontario. You will have to rebuild your credit one on-time payment at a time. For a mortgage, you may need a private lender through a brokerage and/or may require a co-signer.
  
• Check your credit score twice a year. When you check, it is considered a soft inquiry and has no impact on your credit score. Ensure the information is correct as you can dispute details with proof. Simply contact Equifax or TransUnion.

Reference for images included in article: See Sample Credit Score from Equifax Canada.

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Susan Williams is a mortgage agent in Toronto with Mortgage Architects. For help you with all your mortgage and refinancing needs, email her at susan.williams@mortgagearchitects.ca.

What stricter mortgage rules mean for you

The Office of the Superintendent of Financial Institutions (OSFI) is drawing a line in the sand for anyone who applies for an uninsured mortgage in Canada in 2018: Qualify at the new restrictive standard or explore alternative options.

Here's what you need to know about the new mortgage stress test:

1. Takes effect January 1, 2018

2. Affects applicants for low ratio mortgages who are seeking to refinance or purchase and have home equity (or a down payment) of 20% or more.

3. Does not affect renewals with the same lender. If switching to another lender, the stress test will apply.

4. The 'stress test' aspect of the new rules comes in the form of higher qualifying rates. Here's how it works:

• Today's posted rate is 4.99%.
  
• An applicant may be able to secure a 5-year contractual fixed rate of 3.50%
  
• When the stress test is introduced, the applicant must qualify at the posted rate or the contractual 5-year fixed plus 2 percent, whichever is higher.
  
• For example, 4.99% posted rate or 3.50% + 2%. The applicant must qualify at 5.50%. He or she will be able to afford less house than under the previous rules. And some applicants will not qualify. They may need a co-signer. Or may seek a solution with an alternative lender through a mortgage broker.
  

5. Some lenders may allow applications that start in 2017 but are funded in 2018 to qualify via 2017 rules.

6. Applicants can lower their payments by choosing a longer amortization period such as 30 years or more at select lenders.

7. Credit unions may or may not adopt the new OSFI qualifying standards. Your mileage may vary.

Before Choosing Fixed, Consider a Hybrid Mortgage

A reader writes: “My wife is conservative and wants fixed, but I think going variable makes more sense. What mortgage option should we choose?”

When clients can’t decide between choosing a fixed or a variable rate mortgage, I often raise a pretty strong alternative that offers the best of both: “Have you considered splitting the mortgage into one part fixed and one part variable?”

According to industry association Mortgage Professionals Canada, about 4 per cent of mortgages are classed as ‘hybrid’ or ‘combination’ mortgages that may consist of fixed and variable components, or may split the mortgage into various term lengths. The hybrid option I recommend consists of a 50/50 split between fixed and variable.

With Canadians fearing additional rate hikes in the coming months and years, the shift in favour of fixed over variable is on, according to MoneySense magazine, citing data gathered from a rates web site. More than half are now opting to lock into fixed rates.

Here are five points to ponder when considering the hybrid mortgage option:

1. You get the predictability of a fixed rate and the savings of a variable rate. However, some experts believe the spread needs to be at least two percentage points to see significant benefits.

2. While interest rates are notoriously difficult to forecast, a hybrid 50/50 split can leave you with more mortgage principal paid down relative to interest in three scenarios over the next three to five years:

• rates increase slightly
  
• rates stay put, or
  
• rates decline

3. If rates increase substantially during that period, there is good news and bad news. The good news is that 50 per cent of your mortgage is locked into a fixed rate. The bad news? The remaining 50 per cent is exposed to rate fluctuations. An all-fixed option is best if you don’t have the financial flexibility or risk tolerance to deal with that exposure.

4. You may lock in the variable rate at any point. However, you will likely pay a three month interest penalty to do so and will have to negotiate the fixed rate.

5. Keep it simple. Make sure that both fixed and variable segments have the same term length – say 5 years – which gives you full flexibility to switch lenders once both terms expire.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada. Email: susan.williams@nbc.ca Twitter: @YMJourney

Online and instant – a look at e-mortgage trends

On the heels of Millennials will be a tech savvy, social media aware cohort known as Generation “Z". Born after 1997, Generation Z will be comfortable banking online, applying for mortgages via mobile apps all the while – at least according to Wikipedia -- being more risk averse in their outlook than previous generations.

When the time comes, will they routinely meet in person with a mortgage expert to get a home loan or home equity line of credit?

It seems that a purely digital mortgage application experience will inevitably become mainstream in the next 10 years as the oldest members of Generation Z turn 30.

Online and Instant

This summer, Australian fintech outfit Tic:Toc Home Loans (https://twitter.com/tictochome) announced, in partnership with Bendigo and Adelaide Bank, the world’s first instant home loan. The system can approve a loan in 22 minutes and provide competitive rates.

In Canada, the consumer isn’t the obstacle for change. As CMHC reports, “Almost half of mortgage consumers (48%) agree they would feel comfortable using more technology to arrange their next mortgage transaction.”

And in the United States, 62% of homebuyers under 35 would use their lender’s mobile app to apply for a mortgage if given the option, according to a JD Power Survey.

Digital and Hassle-Free

Two startups in the United Kingdom – Habito and Trussle -- are trying to gain market share by taking the mortgage advice and application process entirely digital. Habito claims to generate approvals seven times quicker compared to a traditional process involving a human broker while Trussle shrinks the time for a quote to three minutes, on average.

Habito guides customers through the virtual mortgage application using chatbot conversations. Salary, employment history and other personal information are gathered in order to assess a customer’s creditworthiness, speeding up approvals and cutting out human advisors.

Personal service in demand

Not everyone will welcome a digital focus. In the recent CMHC survey, “the majority of mortgage consumers agree that it is still important to meet face to face with their mortgage professional when negotiating (69%) and finalizing their mortgage (70%).”

Artificial Intelligence is changing the mortgage industry. Personal touch will give way to a more efficient user experience and 24/7 convenience. For better or worse.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada.
Email: susan.williams@nbc.ca Twitter: @YMJourney

Your rainy day funds may hold the key to mortgage approval

The 80/20 rule is alive and well in the land of mortgages. Roughly 80% of successful applicants qualify based on having enough income to cover their housing and other debts while the remaining 20% have modest reported income and instead qualify because they have liquid assets at their disposal in lieu of income.

Let's explore how fictional client Jeremy got approved using the funds he set aside for a rainy day.

Jeremy is a self-employed millennial, and also very smart. He's been scanning realtor.ca diligently for the past 6 months and pounced on a power-of-sale condo in North York, a rare find. But when I crunch the numbers, even after making his desired down payment of 35%, his debt service levels are still too high.

His Total Debt Servicing -- or percentage of income that pays for housing and other debts such as car loans and credit cards -- is 85%. Banks prefer the TDS to be 40% or lower.

Often, an out-of-whack debt servicing level can mean the end of an otherwise promising mortgage application. But, in Jeremy's case, he's got an ace up his sleeve in the form of liquid assets above and beyond his down payment.

How Jeremy's rainy day fund will get him approved

The standard way to get approved for a mortgage is to have a strong credit rating and enough income to easily cover the debt servicing of the mortgage, taxes, condo fees, heating and any other debts.

From the bank's perspective, Jeremy is an ideal candidate to qualify based on assets rather than income. He is currently renting and owns no other properties. The condo he is buying will be his principal residence. His T1 General shows an income of $50,000. Even better, after the downpayment he will have an $85,000 rainy day fund. His liquid assets will break down as follows:

• TFSA of $40,000
• Cash in a bank account of $15,000
• GIC of $30,000

Since these assets have been held for more than 90 days, from the bank's perspective they are part of Jeremy's tangible net worth.

Based on one bank's rainy day fund qualification criteria, Jeremy is well positioned to qualify for a mortgage if he has a good credit score plus substantial liquid assets. The calculation is as follows:

• Mortgage amount x 0.0065 x 36 months

Since Jeremy is requesting a $350,000 mortgage, the calculation is as follows:

$350,000 x 0.0065 x 36 = $81,900 He will require $81,900 in liquid assets in order to qualify for the mortgage. His rainy day fund of $85,000 means approval is a near certainty.

Other options

Given his strong financial position, Jeremy could use some or all of his $85,000 rainy day fund to do one or both of the following:

• Pay down current debt to get his debt service levels in line
• increase his down payment

However, he's happy leaving his rainy day fund intact, just in case.

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Susan Williams is a Mortgage Development Manager with National Bank of Canada.
Email: susan.williams@nbc.ca Twitter: @YMJourney