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.