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.