A conventional mortgage or a collateral one: which is best for my home?
Last update : 2023-03-01 09:22:30
The type of mortgage with which you choose to finance your home will greatly influence your financial management. This is why it is essential to choose wisely between a conventional or a collateral mortgage.
Among the different mortgages offered in Quebec, you will inevitably come across these two types of contracts – but they could not be more different. Before committing to a conventional or collateral mortgage, you need to know the differences between the two, as well as the potential advantages and disadvantages of each of them.
Your decision will have an impact on your ability to transfer your loan to a new financial institution, your capacity to borrow additional funds from your lender or another bank, and the possibility of registering for the discharge (release) of your mortgage.
Don’t hesitate to ask your mortgage broker for advice! This expert will not only be able to inform you more about the distinctions between the types of mortgages but will also be able to advise you on which one is best suited to your situation.
Conventional (or traditional) mortgages
A conventional mortgage, also known as a traditional mortgage, is probably the most known. However, it is being used less and less by today’s financial institutions.
In the case of a conventional mortgage, the registered amount of the mortgage corresponds to the actual amount borrowed to finance the property. For example, if you buy a home worth $350,000 and decide to borrow $295,000, the mortgage amount will be $295,000.
Since the mortgage amount only covers the amount of the house, the traditional mortgage does not guarantee other loans. For this reason, if you require additional funds to finance a new project (for renovations, purchase of a second home, etc.), you will have to apply for a new loan subject to the lending standards in place at that time.
When signing a conventional mortgage contract, certain credit terms will be published in the land registry, including the specific conditions of the loan (mortgage amount, payment amounts, interest rate, etc.) and the conditions related to the contract (creditor's rights, borrower's obligations, etc.).
Borrowers who take out a conventional mortgage can usually change lenders quite easily by making a mortgage transfer (also called a subrogation) to a new financial institution, with no need to reapply for a new mortgage. All they need to do is transfer their mortgage balance and pay any fees associated with the transfer.
The cancellation of a mortgage, occasionally referred to as a "discharge" or "release," can be done once the loan is repaid in full. This cancellation can be done at the request of the borrower or automatically, depending on the agreement with the lender.
Regular vs. High-ratio Mortgages
There are two types of conventional mortgages; depending on the percentage of down payment you pay, you can choose between a regular mortgage or a high-ratio mortgage.
A regular mortgage can be taken out if the down payment provided is equivalent to 20% of the purchase price of the property. In this case, the borrower is not required to take out mortgage loan insurance.
If the down payment is less than 20%, this will be considered a high-ratio mortgage, and the borrower will be obliged to take out mortgage loan insurance. This is a measure put in place to protect the lender in the event of default.
Note that in all cases, a minimum down payment of 5% will be required for any property under $500,000. Beyond this price, the minimum down payment will be 5% for the first $500,000 and 10% for the remaining amount.
Collateral (umbrella) mortgages
Also known as "collateral security”, a "collateral warranty”, or an "umbrella mortgage”, a collateral mortgage is much more complex than a conventional one. However, it offers greater flexibility for both the lender and the borrower. Some financial institutions only offer this type of loan.
Unlike a conventional contract, a collateral mortgage does not only cover the amount borrowed for the purchase of the property. For this type of loan, the lender and the borrower agree upon a loan contract separate from the mortgage, offering different credit terms. The maximum guaranteed amount is then published in the registry.
The amount registered under the mortgage is therefore greater than the amount borrowed, allowing the borrower to cover other current or future debts that will be contracted with the lender (credit lines, credit cards, car loans, personal loans, etc.). For example, if you buy a home worth $350,000 and apply for a $295,000 mortgage, the registered mortgage amount can be $350,000 in order to offset other future debts.
Regarding subrogation, transferring a collateral mortgage is much more difficult. The new lender might not allow you to transfer the original mortgage, meaning you would have to take out a new mortgage and cancel the old one. This process entails a lot of costs for the borrower.
If a collateral mortgage is cancelled, all debts covered by the mortgage must generally be repaid to the lender before the contract can be terminated. Unlike in the case of a conventional mortgage, the cancellation will not be done automatically; the borrower will have to contact their financial institution to inform them of their intention.
Advantages and disadvantages of supplementary funds
By guaranteeing a higher amount, a collateral mortgage allows the borrower to obtain additional funds, up to the agreed amount, without the need to obtain a new mortgage. It therefore avoids paying the costs involved in a new loan.
The additional mortgage funds can be used for various projects, whether related to the property or not (e.g., renovations, purchasing of a second home, etc.). This ability to access credit more easily can be particularly advantageous when used well, but it can also encourage more borrowing and therefore increase debt.
It should also be noted that supplementary funds are not granted automatically. The borrower must first reapply according to the credit standards in force and obtain the authorization of their lender. The request for funding could therefore be refused regardless.
Comparative table of the two types of mortgages
In order to help you better understand the difference between the two, here is a visual summary of the different characteristics of collateral and conventional mortgages.
Corresponds to the amount financed.
Greater than the amount financed.
Credited terms are entered in the land registry.
Creation of a credit agreement separate from the mortgage to establish the credit terms.
Guarantees the mortgage used to purchase the property.
Usually guarantees several current and future debts.
A new loan must be taken out to obtain supplementary funds.
Fees may apply.
Additional funds are secured without having to apply for a new loan.
Fees apply for the transfer.
The repayment of other debts is not a prerequisite for the transfer.
A new mortgage must be granted by the new lender and the original mortgage must be written off.
Fees apply for the setting-up and cancellation of mortgages.
Other debts usually have to be repaid to the original lender.
Cancellation of the mortgage
Possible as soon as the mortgage is repaid in full.
Automatic or at the request of the borrower.
Possible when all debts secured by the mortgage are repaid.
At the request of the borrower.
In any case, before choosing your mortgage, take the time to compare several offers from different financial institutions to find the one that best suits your needs. Also, make sure you understand the pros and cons of the mortgage you choose.
Did you know that a mortgage broker can help you find the mortgage you need without risking damage to your credit score? Learn more about the benefits of working with a broker and the role they play.
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