When you apply for a mortgage to buy a property you also agree to provide the lender with security, usually the home you are buying. This means that if you default on the terms of your mortgage loan, such as failing to make a payment, the lender can foreclose on the home and sell it to get their money back. Once this agreement is made, the lender will register it as a “charge” against your property at the land registry office. The charge will be registered either as a standard charge or a collateral charge.
A standard charge is registered for the actual amount of the mortgage loan. If you need a mortgage loan of $450,000, the lender will register the charge for $450,000 as a liability against your property. The charge will include the specific loan terms (such as the mortgage loan amount, interest rate, term, and payment amount) as well as additional terms, (such as your responsibilities as the borrower and the rights of the lender;) which is then registered on title against your home.
A collateral charge can be registered for the exact amount of the mortgage loan or for a greater amount. If you require a mortgage loan of $450,000 to buy a home, the collateral charge may be registered for $550,000 as a liability against your property. By registering the charge for more than what you borrow it becomes possible for you to qualify to borrow more money through future loans or other credit agreements that can be secured by the existing collateral charge, all without having to discharge the loan and go through a costly refinancing.
The specific mortgage terms are in a separate document called the “mortgage loan agreement”, which is not included with the document registered on title. The registered charge document may list loan details that are different than those in the mortgage loan agreement. (More on the pitfalls of this arrangement later.)
A discharge is a document issued by the lender, usually with a title such as “Discharge of Mortgage” or “Satisfaction of Mortgage,” and removes a charge from the title to your home. This usually happens when you transfer your mortgage loan to a new lender or when you pay your loan in full. When the discharge is registered, the lender loses any rights it would have had against your home under the mortgage security.
With a standard mortgage charge your lender will either automatically discharge the mortgage security or wait for you to request that they do so. For a collateral mortgage charge, you will only be able to request a discharge when the mortgage loan is paid in full AND all other loans secured by the charge are also paid in full.
The risks of a collateral mortgage
Lets go back to the pitfalls mentioned earlier about the registered charge document versus the mortgage loan agreement. In a standard mortgage you agree to a set interest rate for the length of your term (usually 3 or 5 years.) One very risky aspect of a collateral mortgage is that your lender may register your loan at one interest rate, but list a much higher rate on your mortgage document. This gives the lender the ability to charge you a higher interest at any time before the end of your term, with or without justification or negotiation, because you signed the document listing a much higher rate.
In a standard mortgage, if you default on your mortgage agreement you will have time to restructure your finances, get up to date, and then renew with your lender, or find a new mortgage. In a collateral mortgage, the lender may foreclose on the property immediately should you fail to live up to any one of your obligations in the mortgage agreement, including but not limited to: non-payment of property taxes, non-payment of insurance, non-payment of condo fees, and other terms of default that are outside of your control, such as one bank’s policy to place the mortgage loan in default upon the death of either partner to the mortgage. Although the courts will give you time to arrange your finances and redeem your property, after a foreclosure is launched other lenders are far less likely to work with you, or may only do so with higher rates and fees.
Another risk of a collateral mortgage is that it can be used to secure any existing and even future debts you have with your lender, such as a vehicle loan or credit cards. Which means the bank could move to foreclose on the property if you default on any of your other loans. Many collateral mortgage borrowers don’t even know these details because they are only written in the fine print of their agreement and not mentioned face to face before all the paperwork is signed.
The most concerning aspect of a collateral mortgage is that the lender can demand the loan be paid in full WITHOUT having to justify the reason. However, lenders usually want to keep your business and continue collecting interest from you.
A collateral mortgage allows you be approved for a second mortgage, also known as a Home Equity Line of Credit (HELOC) without having to go through the mortgage signing and registration process again. A HELOC is a loan that uses the equity in your property, which is the market value of your property minus what you owe on the mortgage. Equity can increase or decrease, but usually only grows over time.
Tapping into your home’s equity can be a big help when you need access to large amounts of money, but you are still required to apply and be approved. If your lender denies you you’ll have to try to move your entire mortgage loan to a new lender, but only IF your initial lender will allow you to break with them (per your mortgage agreement) AND if another lender will agree to take you on as a client. Once your initial lender has denied you other lenders are unlikely to approve you.
Who should use a collateral mortgage
Most institutions offer collateral mortgages, but not all borrowers are suited to them. Those who have a low risk for financial vulnerability, are unlikely to experience a life event that may cause them to default on their loans, and have sufficient net worth that they could liquidate investments to cover debts are those who could comfortably apply for a collateral mortgage.
Despite all that, it is not likely any borrower could confidently say that nothing in their personal or financial life will change over the course of a mortgage (which is typically 25 years.) Standard mortgages are much safer, more transparent, and have better stood the test of time in court compared with collateral mortgages.
Should you have any other questions or want to find out what kind of mortgage charges were registered on your title, please contact me at 403-241-3255.