Understanding Collateral Mortgages When Mortgages Don’t Add Up

Date: April 14th, 2016
By: Ron Thibeault

I would hazard to guess that every Realtor in Calgary (and the rest of Canada) has been mystified when they see a mortgage registered on a title that is for the same amount as when your Seller purchased the home. I know because I have received a number of phone calls about this very issue.

The concern for you as an agent is to ensure that there is enough equity in the Property to satisfy the terms of the contract but also ensure that you get paid; this is after all an occupation and not a hobby. What you likely don’t know is that your Seller likely executed a newer product called a collateral mortgage that most banks are now pushing their clients into. In most cases, it isn’t properly explained to your clients and they have no idea what they have agreed to.

Not so long ago, your clients were offered 2 main products as a “mortgage” solution: either a fixed rate mortgage that was registered for a set amount at a set rate or a line of credit where the security is registered for the maximum amount approved at the approved rate; pretty straight-forward in terms of understanding. If ultimately you were having issues with your lender you could talk to a competitor, pay a nominal fee (often waived) and walk across the street. This has changed with the use of collateral mortgages.

A collateral mortgage is effectively a promissory note that is secured by a mortgage on a property. The promissory note can be for significant value even though the Buyer did not borrow that much money. Typically what you see are collateral mortgages registered for the purchase price (or appraised amount if it is higher). The rate on the registered mortgage is also significantly higher than the client agreed to (Prime + 10% for TD, Prime + 7% for RBC, etc.). Effectively, what lenders are doing is finding a way around the maximum allowable security by making the mortgage security for a separate promissory note.

What your client hears when discussing this with their lender (if it is discussed at all) is that this is a great product that will allow them to borrow future advances as long as the property qualifies, they qualify, the loan never exceeds the registered amount or the registered rate. To your clients this sounds really exciting because they can save on future legal fees and have fewer issues should they need or want more money from the lender. However, there are some negative aspects of this loan that need to be divulged.

There are some issues that Buyers have to be aware of when the lender “fits” them into a collateral mortgage. Most importantly, there is a reduction in the flexibility in changing banks. If you have a collateral mortgage you cannot simply “transfer” to another institution like with a standard mortgage. You will have to discharge the collateral mortgage and reregister another mortgage with a different lender; all at your own costs. If you want to do this mid-term in your mortgage you will also have to pay any mortgage payout penalties that are included.

Another issue relates to obtaining other loans from different lenders. Because the collateral mortgage has a right of re-advance (i.e. additional money can be advanced on it) subsequent lenders will look to the maximum that can be advanced on the loan and not the balance when making a decision on a loan. Say for example you have a collateral mortgage for $500k on a home that is valued at $500k but the balance you owe is only $200k. You find out that a different lender is offering great rates on home equity lines of credit. When you approach that bank thinking that there is about $200k of equity left over ($500k x 80% = $400k – $200k balance = $200k equity) you will be denied because the collateral mortgage, which is a first charge, can always be brought back up to $500k meaning there is potential no equity for the 2nd lender to attach to.

The final issue with some collateral mortgages is that they can be used to secure more than just your home. In some cases, lenders include other loans like credit cards, etc. In return the client usually gets a secured rate on those products. The danger with this type of product is that other debts secured by the collateral loan could result in action being taken again everything secured. On other words, defaulting on a credit card could technically result in action against your home. Not all lenders use this form so it is important for a client to ask their lender about this issue specifically.

Are collateral mortgages a good change? Depends on who you are. In the majority of cases, clients have long standing relationships with their lenders and in other cases people rarely change lenders other than when they are selling their property. Whether it fits for your client is a question that their mortgage broker or lender has to address with them. The key is for them to address it early and not wait until the client attends the lawyers’ office to find out what they have agreed to.

Ron Thibeault