When you’re buying a house, you may be so focused on borrowing money to cover the purchase that you don’t think about whether you might eventually want to borrow additional funds. If you don’t plan to borrow any more money, a standard or traditional mortgage may be a good fit for you.
But if you think you may need to borrow more money in the future, such as for renovations, you may want to consider a collateral mortgage.
A collateral mortgage allows you to borrow more than your mortgage amount from your lender using your home as collateral. You’ll choose the additional amount when you’re approved for your mortgage. Since the funds are pre-approved, you won’t pay any additional fees to access them like you would when refinancing.
For example, a home equity line of credit (HELOC) is a collateral mortgage, since you’re able to access the equity you’ve built.
While you may not have heard of the term, collateral mortgages are pretty common. Most lenders offer both conventional and collateral mortgages. Some lenders will even allow you to secure other loans using a collateral charge mortgage. Essentially, your home would act as collateral for other financial products, such as an auto loan, line of credit, etc.
With a standard charge mortgage or conventional mortgage, only the actual amount of your mortgage is registered. No credit portion is added. If you need to access the equity in your home later, you’ll have to formally apply, re-qualify for the additional funds and register a new mortgage. This process would come with fees.
However, a collateral mortgage means you’ve planned ahead and you’ll have access to borrow funds when you need them, without paying fees.
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Getting a collateral mortgage is straightforward, but it involves a few steps.
Let’s assume you’ve purchased a property for $500,000 and you have a 20% down payment ($100,000). That means you’ll need a $400,000 mortgage. Your lender might offer you a collateral mortgage of up to 125% of the value of your home. That means your collateral mortgage could be registered with a value of $625,000 ($500,000 x 1.25).
Every lender has its own criteria to determine how much extra money they’ll register as part of a collateral mortgage. Some lenders might not allow more than the original mortgage amount. Either way, per government regulations, you can borrow up to 80% of the appraised value of your home (minus what you still owe) — which is especially helpful if the value of your home goes up.
Let’s say it’s been a few years since you bought your home and its value has gone up 10%. Your home is now worth $550,000, and 80% of that is $440,000. We’ll also assume that you now only owe $350,000 on your mortgage because you’ve been making payments over the years. That means you have $90,000 ($440,000 – $350,000) in equity available to borrow. If your property continues to increase in value, you’ll have access to more funds. However, the maximum you’ll be able to borrow is the original $625,000 at which your collateral mortgage was registered.
Some people see the potential benefits of collateral mortgages, while others are firmly against these financial tools. Understanding the pros and cons of a collateral mortgage is essential, as it’ll help you decide if it’s the right mortgage for you.
Collateral mortgages are an attractive option since they’ll allow you to access the equity in your home immediately without having to pay any fees. With interest rates as low as they’ve been in the last few years, collateral mortgages can be an opportunity to borrow cheap money.
Remember, if you get a collateral mortgage, you can choose the amount (up to your lender’s limit). Even if your lender offers up to 125% of your home’s value, you can be a bit more conservative and just register for the actual value.
Barry Choi is a personal finance and travel expert. His website moneywehave.com is one of Canada's most trusted sites when it comes to all things related to money and travel. You can reach him on Twitter: @barrychoi.