Over the past week I have dealt with two situations where a client had a collateral mortgage on their home. In both cases, they had no idea. From the perspective of someone who often sets up second mortgages – they can be a real headache.
A collateral mortgage is quite common. The banks like to describe these as being of benefit to the borrower – in that if the client wishes to increase their mortgage later, they do not need to re-register the mortgage.
While this sounds like a benefit – it cannot be forgotten that you will still need to QUALIFY for the additional advance, at the time you request it. In some cases, this is no big deal.
However, many of the people who call me are in some kind of financial distress – at the very least they are uncomfortable financially. So when they go back to the bank that holds their mortgage, ask for a larger mortgage amount or a secured line of credit – the bank turns them down as they do not qualify.
THEN – I get the call. Unfortunately, a second mortgage is normally available up to certain TOTAL loan to value percentages. And the TOTAL loan to value calculation on a collateral mortgage is based on the amount REGISTERED, not the balance remaining. In many cases, this prevents a second mortgage altogether – unless the amount registered on the first mortgage is reduced, or the first mortgage is converted from a collateral charge to a conventional mortgage.
As that probably made no sense to you, let me give you a hypothetical example:
Your home is worth $400,000. The bank gives you a $275,000 mortgage. At the moment you call me, you have paid down the mortgage, so the balance owing on the mortgage is $269,000.
If you have a conventional mortgage, and you are looking to obtain a second mortgage up to 80% loan to value – the math works like this:
$400,000 X 80% = $320,000 – $269,000 balance remaining on first = $51,000 second mortgage
If you have a collateral mortgage, even though you only borrowed $275,000, the bank might have registered $330,000 on title (Yes – far more than you borrowed!). So if you are looking to obtain a second mortgage up to 80% loan to value – the math now works like this:
$400,000 X 80% = $320,000 – $330,000 = MINUS $10,000
In other words, in the second (collateral mortgage) scenario – there can be NO second mortgage at 80% loan to value, due to the collateral charge of $330,000.
As the bank has refused to lend any additional money at this time, the client is in a bind. They cannot get additional financing from the bank, but the mortgage the bank registered prevents others from lending! Now the client has no choice, and must request that the bank either reduce the charge to the amount owing, or convert it to a conventional mortgage. This can take some time, if it happens at all.
The client could also refinance entirely, paying out the existing first mortgage. However, depending on the pre-payment penalty, this could cost tens of thousands of dollars, and so be financially prohibitive.
In summary, then, be careful of the box you check off when you sign a bank mortgage. You might wish to have them register what you are borrowing, not some other (greater) number. It might never matter – but who expects to be in financial trouble 2-3 years from now?