Back in 2011, TD came out with collateral charge mortgages. The other banks soon followed suit. They found out that 80% of clients would stay with them regardless of the rate when they found out that it would be expensive to move their mortgage. Here's an article written at the time about the pitfalls of collateral mortgages. It still rings true today.
Many banks are now asking borrowers to sign collateral mortgages, but you could end up tied to this bank for life.
When you apply for a
mortgage, you usually just ask about the term, amount, interest rate and
monthly payment. Not many people understand the difference between a
conventional mortgage and a collateral mortgage. Yet many banks are now
asking borrowers to sign collateral mortgages — and it could result in
them being tied to this bank, for life.
With a normal
conventional mortgage you bargain for a set amount, rate and
amortization. Say the property is worth $250,000 — you bargain for a
$200,000 loan, at 3.5 per cent, a five-year term/25-year amortization,
payments of $998.54 per month.
A conventional
mortgage is registered against the property for $200,000. If all the
payments are made on time, the mortgage is renewed on the same terms
every five years and no prepayments are made, the balance is zero after
25 years.
Should another lender
decide to lend you money as a second mortgage, there is nothing stopping
them from doing so, subject to their own guidelines. Under normal
circumstances the principal balance on a conventional mortgage goes only
one way, down. In addition, banks will accept “transfers” of
conventional mortgages from other banks, at little or no cost to the
consumer.
A collateral mortgage
has as its primary security a promissory note or loan agreement and as
“backup,” a collateral security, being a mortgage against your property.
The difference is that, in most cases, the mortgage will be for 125 per
cent of the value of the property. In our example, the mortgage
registered will be for $312,500. But you will only receive $200,000. The
loan agreement will indicate the actual amount of the loan, interest
rate and monthly payments.
The collateral
mortgage may indicate an interest rate of prime plus 5-10 per cent. This
will permit you to go back to this same bank and borrow more money from
time to time, without having to register new security. The lender will
offer you a closing service, to register the mortgage against your
property, at fees that will be cheaper than what a lawyer would charge
you. Sounds good so far, doesn’t it?
However, this collateral loan agreement has different consequences, which are usually not explained to the borrower.
• Most
banks will not accept “transfers” of collateral mortgages from other
banks, so the consumer is forced to pay discharge fees to get out of one
mortgage and additional fees to register a new mortgage if they move to
a new lender. Thus the bank is able to tie you to them for all your
lending needs indefinitely because it will cost you too much to move.
• Lenders
may be able to use the collateral mortgage to offset any other unpaid
debts you have. Offset is a right under Canadian law that says a lender
may be able to seize equity you have in your home, over and above the
mortgage balance, to pay, for example, a credit-card balance, a car
loan, or any loan you may have co-signed that is in default with the
same lender. In essence any loans you may have with that lender may be
secured by the collateral mortgage. Nobody goes into a mortgage thinking
about default, but “stuff” happens in people’s lives and 25 years is a
long time.
• Let’s
say your house value is $200,000. A collateral first mortgage
registered on the property is $250,000. The amount owing on the mortgage
is $150,000. If you were to need an additional $20,000, but the lender
declines to lend it for any reason, then practically speaking you won’t
be able to approach any other lender. They will not go behind a $250,000
mortgage. Your only way out would be to pay any prepayment penalty to
get out of the first mortgage and pay any additional costs to get a new
mortgage.
• Let’s
say your mortgage is in good standing but you default under a credit
line with the same bank. The bank could in most cases still start
default proceedings under your mortgage, meaning you could lose the
house.
• Some
lenders are offering collateral mortgages in a “negative option
billing” manner. Unless you are informed enough to say you want a
conventional mortgage, you will be asked to sign documents for a
collateral mortgage.
One bank is only offering collateral mortgages.
I spoke with David
O’Gorman, the president and principal mortgage broker with MortgageLand
Inc. He tells me it is his duty under the law to ensure the
“suitability” of any mortgage he arranges for a consumer.
He would be hard
pressed to justify the recommendation of this type of collateral first
mortgage to any consumer, without disclosing both verbally and in
writing the points listed above, and he believes the consumer should
have their own lawyer review everything before they sign.
Mark Weisleder is a lawyer, author and speaker to the real estate industry. Email mark at mark@markweisleder.com
