As you are securing a downpayment, getting a mortgage, and buying a home, you probably aren’t thinking too much about big purchases in the future.
However, as you start paying down your mortgage, unexpected expenses like housing repairs, renovations, or vacations may come up. This is why it’s important to consider opting for a collateral mortgage when you buy your home.
What is a Collateral Mortgage?
A collateral mortgage, also known as a collateral charge mortgage, is a type of loan that allows you to use the equity in your home as collateral. In other words, you can borrow more than your required mortgage amount.
This type of mortgage allows you to continuously borrow from home equity increases, meaning that as you pay down your mortgage or as the value of your home rises, you can borrow more money. You can think of it as a loan with a credit limit that could potentially increase every year.
A collateral charge mortgage is similar to a HELOC since they both turn home equity into accessible funds. However, once you've gained some equity, you can obtain a HELOC and its borrowing power after purchasing a home. In contrast, a collateral mortgage determines this amount when the mortgage is initially approved.
Lenders who offer this type of mortgage typically register the amount you can take out to be around 125% of the property value.
Pros and Cons of a Collateral Mortgage
While some people think that collateral charge mortgages are hugely beneficial, I know a lot of folks can be nervous about them.
Pros of a Collateral Mortgage
Your loan size increases with your home value
As you pay down your mortgage or make improvements to your property, you can gradually increase your potential loan amount.
Lower interest rate
By using collateral to secure the loan, the borrower can get a lower interest rate than with a conventional loan. This is especially beneficial if interest rates increase.
Lower monthly payment
With a collateral mortgage, you can get a longer repayment period, potentially reducing the monthly payments significantly. This can make the loan much more manageable in terms of your overall financial situation.
Access to funds
If you need some quick cash, you can use the equity you've built in your house to take out a mortgage and get the funds you need. You can use this loan for anything you need, whether it's paying off a credit card or repairing a car.
No legal costs
Because collateral mortgages are set up from the beginning, you won’t have to pay legal costs when borrowing the money, as you would if you were refinancing.
Cons of a Collateral Mortgage
You may pay a higher interest rate on the additional amount you borrow. If you don’t read the fine print, you may agree to pay more interest over time on any other funds you borrow.
Extra funds aren’t guaranteed
If you lose your job, rack up credit card debt, or have a financial emergency, your lender is not required to release the amount they initially agreed to lend you.
Other lenders may want to avoid you
Many lenders agree to collateral mortgages that are more than 100% of the home’s value. You won’t be in a good situation if you can't access these funds.
For example, taking out a collateral loan for $600,000 on a $500,000 property makes you look like a credit risk to other lenders.
More fees apply when switching lenders
Collateral mortgages are registered with your original lender, so even if your term is up, you’ll likely have to pay extra fees when switching to a new lender.
You could lose your home
If you default on the loan, you may not be able to get your home back, as the lender can seize it and sell it to recoup their losses.
Is a Collateral Mortgage Right for You?
Setting up a collateral mortgage can make sense in some instances. Many homebuyers take advantage of this option to finance renovations on a fixer-upper, or to consolidate debt from other sources. Rolling higher-interest debts, like a car loan, into your mortgage can be a great choice since mortgages often have much lower interest rates.
It’s important to consider all of your options before taking out a collateral mortgage. If we decide to go this route when working on your mortgage, we’ll work together to make sure you understand the terms of the loan and what will happen if you default.