All about collateral mortgages

Are you planning to take out a mortgage to buy a home? Financial institutions offer borrowers several types of mortgages, including collateral mortgages.

What is a collateral mortgage? What are the advantages and disadvantages? To help you make the right choice, we explain the basics of this type of loan.

What is a collateral mortgage?

You may have heard collateral mortgages referred to by different names, as they have several. Umbrella mortgage, wraparound, mortgage security deed or equity release: these are all terms that refer to a collateral mortgage. But what is it exactly?

A collateral mortgage is often defined as a way to obtain additional financing, at an advantageous rate, through your property. This is because, in addition to the amount borrowed, it covers the amount of any other current or future debt you may have, such as a line of credit, personal loan or car loan. However, these other debts have their own terms.

In doing so, it gives the lender a much greater right than a traditional mortgage. Some financial institutions have even abandoned the traditional mortgage and now only offer the umbrella mortgage. 

How does collateralization work?

Interested in this type of financing? Let's take a closer look at how it works and what you can do with the additional funds you're securing.

Eligibility for a collateral mortgage

As with any mortgage, you need to qualify with the bank to get a collateral mortgage. Specific eligibility requirements may vary from lender to lender, but in all cases, you will need to show that you have sufficient financial capacity and a good credit history.

Deed of trust

For this type of loan, the bank will ask you to sign a mortgage security deed instead of a standard mortgage loan agreement. This is because, with a collateral mortgage, the lender and borrower enter into a loan agreement separate from the mortgage to agree on the various loan terms.

Additional funds

In a collateral mortgage, the amount registered is greater than the amount borrowed for your home. For example, if you need a mortgage of $275,000, the registered amount could be $350,000 to cover other current or future debts with the same bank.

This difference between the registered amount and the approved amount for the purchase of your property allows you to borrow additional funds, subject to the lender's approval. Please note that a collateral mortgage does not guarantee additional financing.

So if you're planning an expensive renovation, a collateral mortgage could make it easier for you to get the financing you need. With a traditional mortgage, you would have to reapply for a loan, which would incur additional costs.

Financing another property with no down payment

In addition to making it easier to finance certain work and life projects, many people also find that a mortgage is a good strategy for buying another property using the equity in your home.

Once you've paid off your mortgage sufficiently and have some equity, it is possible to use your home as leverage and collateral to purchase another property, such as a vacation home. This allows you to finance your new purchase with no cash down and avoid the costs normally associated with refinancing.

Note, however, that the money used is not cash and no transfer is made. Instead, the mortgage balance increases to cover the new debt.

What are the advantages of a collateral mortgage?

Getting a collateral mortgage can:

• Give you more flexibility than other forms of credit;
• Improve your access to credit by using your home as collateral;
• Offer better interest rates on loans secured by the collateral;
• Guarantee several loans while avoiding notary fees, since it can be reused up to the maximum amount allowed.

What are the disadvantages?

However, obtaining a collateral guarantee comes with its share of risks:

• Easier access to credit may encourage you to borrow more;
• If you have several co-borrowers, the mortgage guarantees the debts of each of them. You could therefore be held liable for any of these debts;
• Transferring an umbrella mortgage is more difficult, which could limit your options at renewal time and reduce your bargaining power at the end of the term;
• Obtaining a discharge of your mortgage may be more complex as you may be required to repay all debts contracted with the financial institution.

What type of mortgage should I choose?

Are you interested in an umbrella mortgage? Before making a final choice, it is important to compare all your options to make sure you're making the right decision. In addition to the collateral loan, there are other types of mortgages whose features may be better suited to your situation:

• Conventional;
• High Ratio;
• Open;
• Closed.

Each has its advantages and disadvantages. To make sure you understand the differences, don't hesitate to consult a mortgage broker.

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