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Collateral Charges

Mortgages are loans that are secured by your home.  A bank/lender will register this security in one of two ways, a standard charge or a collateral charge. The standard charge is the traditional method used for many years.  Collateral charges, on the other hand, are more typically suited for re-drawable Home Owner Lines of Credit (HELOC) but nevertheless, can be used to register any mortgage loan. 

Bottom Line:  A collateral charge is necessary for some mortgage types such as HELOC’s or Combination loans.  They can be embraced for that reason. However, all else equal, for a regular amortizing mortgage a collatreral charge should be avoided because of the inherent disadvantages. 

What are the key differences?

First, unlike a standard charge, a collateral mortgage cannot be transferred to another institution. In order to move the mortgage to a new financial institution, it must be registered again, similar to a refinance.  This brings in legal work and additional cost of $1000-1500. The Bank institution that has the mortgage registered as a collateral charge today knows that you won’t want to pay additional costs.  What do you think they are going to do at renewal time?  They are going say; “you’re stuck with us” and offer you a less competitive rate.  Luckily for me, I’m in the mortgage broker market where many lenders are competing for my business.  They are constantly inventing new and innovative methods to transfer or absorb these costs for our clients.

Second, a collateral charge is “re-advanceable” which is why it makes sense for HELOC’s.  Banks will register the collateral charge at 100-125% of the value of your home try to position this as a positive feature to customers because they can refinance without needing to re-register and incur legal costs. However, it comes with two downsides.  One, it assumes you only negotiate with one lender again which is not competitive.  Two, if they decline to lend to you it renders the real equity in your home as worthless to any other lender.  This may hamstring your ability to secure funding.  This is real risk because “life happens” and you never know.

Third, the interest rate set in a standard charge cannot be altered.  A collateral charge on the other hand can have the rate legally increased if the bank chooses.

Forth, the bank has the right, against your wishes, to use the equity in your home to pay any other unpaid debt you have with that bank.  This is a low probability event but all else equal, it’s an additional risk in comparison to a standard charge.

 

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