Do you have a Manulife One mortgage? Or a Scotia Total Equity Plan? How about a mortgage from National Bank, ING or TD? If so, did you understand when you were signing up that you might not be able to transfer your loan in future, or your lender could arbitrarily increase the interest rate for the life of the debt if you miss payments?
That’s because these aren’t really mortgages, but collateral charges. And they’re all the rage among bankers these days. No wonder.
I first wrote about these things two and a half years ago when TD shocked most people by converting all its new mortgage business to collateral loans. Days ago the CBC probed a bit and tried to entrap a lowly TD loans officer, who I hear is now an attendant in the men’s room. It’s probably only a matter of time before conventional mortgages are hard to find, which would be a shame. And a mistake.
Simply put, as I explained before, a collateral mortgage is a loan which is backed by a promissory note which is in turned backed by security, whereas a conventional mortgage is just a loan secured by a house. Normally the only people who are asked to sign collateral mortgages are those who use their houses to arrange lines of credit with balances that can balloon, not a regular mortgage with a fixed amount owing and a standardized payment. With a conventional mortgage there are strict rules about how much you can borrow determined by the value of the property when you take the loan. Not so with a collateral mortgage, because it’s actually a loan which is backed by your promissory note. That means you can borrow more than your house is worth.
That’s why TD, for example, routinely signs up people for 125% of what they actually need to buy a house. The ‘extra’ is available to them as a line of credit to, you know, buy something useful, like a condo.
There are a few things you should know if dealing with some of the lenders mentioned above. First, a mortgage is secured by a house so moving it to a new lender is simple if you get a better deal. But a collateral mortgage can’t move because it’s backed by a note and acts like a personal loan. So it has to be discharged and a new mortgage arranged – a process which costs big.
Second, not only do some lenders register a collateral mortgage for a greater amount than you borrow, but they also register potential higher interest rates. If you screw up and don’t pay on time, the rate could be increased as much as 10%, since the charge is actually registered at a rate of prime plus ten.
Thirdly, collateral mortgages often encompass more than a real estate loan. You can fold in a line of credit or, in the case of the ManOne product, your savings and chequing accounts, car loans and personal borrowings. There are definite advantages to doing this, since every time you’re paid your loan balance falls and interest charges are reduced. But if you fall behind, the lender has the right to up the cost of the entire package.
That’s a big difference from missing a few mortgage payments, receiving a lawyer’s letter, then getting caught up with no threat of a rate change. It might also make you think twice about having a collateral mortgage at the same place you keep your RRSPs, tax-free accounts or your kids’ RESPs. (Better read the mouse print.)
So why would banks be moving in this direction? Simple. Customers get trapped by the legalities of collateral charges and stay customers longer. After all, moving is now complicated and costly. Plus, with a mortgage that can morph into a LOC with no additional fees to pay or apps to complete, it’s just so damn easy to borrow more. And never forget that what’s a debt to you is an asset to the lender – the bigger than better.
Finally, consider this worthwhile observation from Canadian Mortgage Trends: “In some cases, defaulting on another debt owed to a collateral mortgage lender can put your house at risk. That’s because that lender can theoretically seize your home equity if you don’t pay that other debt. (This is called “offsetting” in legal parlance.)”
As I said, some products like ManOne and the Scotia Equity Plan make perfect sense in a perfect world. All the debt in your life is puddled together and offset by all your income and savings. Interest charges can be slashed and debt repayment time crushed. This financing-for-dummies approach works, until something crappy like a job loss or a real estate crash comes along, and you suddenly have fewer options.
Given what’s ahead, I’d want to know that.